Author Topic: Portfolio Concentration  (Read 5948 times)

Viking

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Portfolio Concentration
« on: December 21, 2017, 04:00:50 PM »
I have been thinking about portfolio concentration for many years. On the one side of the fence is the investment industry that requires/advises a portfolio to be diversified in 15 or more stocks, bonds etc. On the other side of the fence are many small business owners who may have their entire net worth tied up in one business (the business they own). There is also the middle ground; Buffett has talked about how 6 decisions over a lifetime can make an inverstor very successful; once you find a great opportunity Ďback up the truckí (concentrate your portfolio).

Letís take two scenarios:
1.) Small business owner whoís entire net worth is tied up in their business (letís assume the business is the average business in the small business universe)
2.) Investor whose entire portfolio consists of Berkshire Hathaway

Which choice carries more Ďriskí to the investor?


rkbabang

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Re: Portfolio Concentration
« Reply #1 on: December 21, 2017, 04:53:11 PM »
You have your choice of meals

1) Dish A prepared by a chef at a small local restaurant.

2) A Delmonico steak from Delmonicoís in NYC.

Which is more risky?

Of course #1 is more risky, you arenít even telling me what it is.

A small businessman has the potential to make a lot more from his initial investment by investing his time and money into his business, but it is certainly more risky than just sitting back and being a passive investor in BRK.

DocSnowball

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Re: Portfolio Concentration
« Reply #2 on: December 21, 2017, 06:02:59 PM »
Great post - Iíve been thinking of the same. After completing my MBA and studying healthcare and investing for two years, I find myself with a very small circle of competence in my area of expertise in a subspecialty of medicine, barely. So I can either concentrate and know what Iím doing, or diversify. Iíve chosen the former and that too in micro and small cap companies (only 2 so far where the initial investment thesis was not disconfirmed), where I have a reasonable idea of their business model, story, valuation and teams. It is def a roller coaster, one has gone from a share price of $3.50 to 27 to 10 over the last year!

Time will tell, but imho wealth is created by concentrating in good ideas, as long as you donít lose money doing so. Otherwise whatís your edge over simply indexing (when valuations are reasonable)

no_free_lunch

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Re: Portfolio Concentration
« Reply #3 on: December 21, 2017, 06:28:53 PM »
I have been thinking about this as well.  I don't know about going all in on just one stock but I have found it very tough to build a diversified portfolio that can beat the market.  I have cut back to only 5 or 6 investments over the past couple years, for me that's quite concentrated.  I hold roughly half of my portfolio in index funds and half spread across this small group of investments.  My goal is to get those 5 or 6 companies down to 3 or 4.  There just aren't that many good opportunities out there so even with 5 or 6 I am compromising.
« Last Edit: December 21, 2017, 06:30:40 PM by no_free_lunch »

Sullivcd

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Re: Portfolio Concentration
« Reply #4 on: December 21, 2017, 07:06:10 PM »
Ericopoly had some great thoughts on this years ago. He thought less about diversification and more about how expensive it was to protect your downside. I thought about this alot with gm last year and have been thinking alot about it with aig for 2018.

randomep

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Re: Portfolio Concentration
« Reply #5 on: December 21, 2017, 08:28:01 PM »

Time will tell, but imho wealth is created by concentrating in good ideas, as long as you donít lose money doing so. Otherwise whatís your edge over simply indexing (when valuations are reasonable)

Many have had phenomenal returns with a large portfolio.  Lynch owned on the order of hundred(s) of stocks and he killed the index. So did Schloss.  Even buffett had around 100 holdings in the 60's.

I think concentration on half dozen stocks should absolutely be value plays. That is they should be sure bets on undervalued assets -- not earnings.


UNF2007

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Re: Portfolio Concentration
« Reply #6 on: December 21, 2017, 09:31:23 PM »
I think for an individual without a team of analysts and limited resources, concentration makes absolute sense. Of the opportunities that I can look at due to time, a small percent I can understand, and a small percent of those are actually good values after I go through the analysis. To me it makes sense that if I work at it I can find 1-2 good ideas a year, but 20 or 30? no way.

kab60

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Re: Portfolio Concentration
« Reply #7 on: December 22, 2017, 01:15:32 AM »
I prefer a concentrated approach, it's just extremely important to consider the downside in those cases. I think the best opportunities I've come across has been good/decent biz facing temporary headwinds combined with an extremely strong balance sheet. Thus you might get a combination sales growth and increased margins, which the market usually re-rates much higher, and worst case you don't lose much.

SMA Solar has been one of those cases for me (twice now). Went from 12 to 50 in a couple of months and with 60-70 pct. of the market cap in cash downside was fairly well protected. Then it went to 20 and back to 40 not long after. I didn't make nearly as much as I should have, because I didn't concentrate enough, but I think those cases (if you think management is aligned) is where it really makes sense to go big. Not when a debt-fueled, price-gouging pharma-rollup is shooting towards the stars.

DocSnowball

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Re: Portfolio Concentration
« Reply #8 on: December 22, 2017, 03:36:21 AM »

Time will tell, but imho wealth is created by concentrating in good ideas, as long as you donít lose money doing so. Otherwise whatís your edge over simply indexing (when valuations are reasonable)

Many have had phenomenal returns with a large portfolio.  Lynch owned on the order of hundred(s) of stocks and he killed the index. So did Schloss.  Even buffett had around 100 holdings in the 60's.

I think concentration on half dozen stocks should absolutely be value plays. That is they should be sure bets on undervalued assets -- not earnings.

Youíre right, everyone has to have their own investment philosophy and it can be concentrated or diversified. Personally, Iíve only found 3 ideas in 3 years despite looking and have not been able to diversify (Goal is 5-15 total investments). If valuation is from growth assets rather than current assets, then a much bigger margin of safety than 25% is desirable, more like 50% plus  - if there is more risk, one has to be sure to be adequately compensated for that higher risk.

Gregmal

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Re: Portfolio Concentration
« Reply #9 on: December 22, 2017, 05:03:22 AM »
I think without question the bigger risk is with the guy running his own business. Plain and simple, if the guy loses his business, he loses everything. If one loses his portfolio, he would still typically have his job which provides income. Add in the current environment in which big box retailers and online shopping are annihilating most small, main street businesses, and personally I think it's a tough sell to take on the risk of being a small business owner right now unless you are very well financially situated.

As for portfolio concentration, I think it's optimal to own a lot but be concentrated in very few, high quality opportunities. For instance I have investments in 20-30 different companies/products. However about 70%of my portfolio is invested in 3 companies. I think it was Bruce Berkowitz who said something along the lines of "diversification will just lead to average results" and that "only a couple great ideas can make a big difference in one's life". I think both are pretty accurate and good to remember.