Geoff Gannon June 20, 2012

Why I Concentrate on Clear Favorites and Soggy Cigar Butts

Geoff here.

The choice between concentration and diversification is a personal decision. But it is also a process decision.

There is nothing wrong with having 50 positions – if you can do that well – or 20, or 10.

I think people fool themselves into thinking they need to have 25 or 50 ideas. But there is nothing wrong with choosing to have that many.


Our Investing Heroes Thought Longer and Traded Slower – Check Their Turnover

Ben Graham and Walter Schloss both owned more than 50 stocks for most of their careers.

However, they turned their portfolios over much less frequently than people do today. So, even when operating at what was for them a frentic pace, they were still probably only adding one new position a month. Certainly not much faster than that. And sometimes much, much slower.

I think there is a limit to how many amazing decisions you can make in a month, a year, etc.

Running a portfolio in a way that requires a good idea every couple weeks is far beyond my abilities.


Limit the Number of Good Ideas Required – Not Necessarily the Number of Stocks Owned

But there are many ways to solve that problem. You can increase concentration. You can increase how long you hold a stock. Or you can buy entire groups of stocks at once. Buying a group of stocks sometimes qualifies as a single decision. I bought 5 Japanese net-nets at once, because I did not know enough about Japanese business to discriminate between Japanese companies that were both:

  1. Profitable
  2. Selling for less than their net cash

So I just bought up 5 such stocks at once. That was my way of making really just one big decision – going more than 40% into Japanese net-nets – without actually having to put 40% or 20% or something into a single Japanese stock.

There was no Japanese stock I felt comfortable putting 20% of my portfolio into. And I did not know how to get comfortable doing that – having never visited Japan and not being able to speak Japanese.

Language was actually the least of my problems investing in Japan. The divide in business culture between Japan and the United States was my biggest problem.

Sometimes, this can be a big issue in Europe as well. Especially when analyzing some companies in southern European countries.


There are Little Exceptions Hiding Everywhere – Europe, Asia, the Midwest

But it is best not to paint countries with too broad a brush.

I think a foreign investor’s image of American business includes stock analysts, earnings calls, and press releases. But there are thousands of public American companies – often far from either New York of Los Angeles – that are as tight lipped as any company you’ll find in less bombastic parts of the world.

I have found Japanese companies with the kind of business culture an American can understand and I have found Portuguese companies with the kind of business culture an American can understand.

It is true, however, that it is easier for an American to understand what management is saying in the U.K., Switzerland, etc.

For me, portfolio concentration is always tied up with ideas like these. Questions of comfort:


  •  Which countries do I invest in?
  •  How many cheap companies can I find in industries I understand?
  •  How many family controlled companies can I find?


If there were 2,000 public family controlled grocery store chains in the United States, I’m sure I would own dozen of stocks. Because that is an industry where I know good management from bad. And where I know what cheap looks like.


Interesting Businesses are Often Unique – And Alleged Comparisons are Often Superficial

But it usually doesn’t work that way. For example, Quan has written about DreamWorks (DWA) recently. The truth is that there is only one DreamWorks. While some might compare a company like Disney (DIS) to DreamWorks – there is really no comparison. All of DreamWorks’s value is in animated movies. Probably two-thirds of Disney’s value is in TV networks today.

Disney and DreamWorks share a past. But not a present.

There are a lot of companies like that. In most markets, there are probably only about 3 companies I would really be interested in owning. When I say market, I do not mean industry exactly.


Market Leaders Don’t Have to be Industry Leaders – Some are Actually Pretty Small

For example, Bank of Hawaii (BOH) and Valley National (VLY) are both banks. But they don’t compete with each other.

Likewise, Village Supermarket (VLGEA) and Arden (ARDNA) are both grocers. But there’s no overlap in their markets.

Well, in a lot of industries the business is not as local as banks and grocery stores. So if I’m only interested in the top 3 or so companies in a market, and if that market is national or international – there’s only a handful of companies per industry I’m really interested in owning.

That is a very different approach from Ben Graham. But experience has taught me that if a company is not among the top 3 players in its market, that company’s future growth is probably pretty worthless to investors.

It is a rare company that can grow profits as fast as GDP while comfortably earning more than its cost of capital. And it’s almost always a company that can break free from the pack and keep pace with the leaders in its market.

That is one approach. Then there are – often at the back of the pack – the true Ben Graham bargains. These are companies selling for less than they could be liquidated for.

That is the Ben Graham approach. The approach I took in Japan.

It works too.


Don’t Waste Time on Borderline Calls – Look for Obviously Unusual Stocks

Most investors spend a lot of time analyzing the companies bunched up in the middle – the ones that are neither definitively cheap nor definitively the pace setters in their markets.

I think that is a mistake.

And it is the main reason I do not diversify.

My ability to tell what the future will hold for the number 4 or number 5 horse is poor. I need an absurdly good payoff on a mediocre prospect or a clear favorite.

I have not had much success betting on anything else.