Diversification

Before moving on, let me clarify one thing; there is nothing wrong with diversification. I have had a diversified portfolio ( 15+ stocks in my book) for a while now as my time for researching stocks was limited. There are plenty of value investors who diversify and outperform the market by a good margin. Walter Schloss comes to mind.

Some well known concentrators

• Warren Buffett/Charlie Munger – While Berkshire holds a great number of stocks, the majority of the stock portfolio is invested in big bets such as Coca Cola (KO), American Express (AXP), Washington Post (WPO) and prior to that  GEICO just to name a few. It was Buffett’s sidekick Charlie Munger who turned Buffett into a more concentrated portfolio.
• Peter Lynch- The worlds greatest mutual fund manager held hundreds and sometimes thousands of stocks at a time. But as he confesses in his book(s), Peter Lynch had a couple of big bets and a ton of small bets so he could keep up with a company’s “story”
• Eddie Lampert- Once considered the next Warren Buffett as the price of Sears Holdings approached $200, Lampert made the majority of his wealth by betting big on the merger of k-Mart/Sears. I believe his cost basis is $1(I might be wrong on this) as he merged the two companies when K-Mart filed for bankruptcy.
• Joel Greenblatt- Probably never believed in diversification. Reading both of his books, Greenblatt constantly advocates making few but big bets. Before I get bombarded with e-mails about the magic formula strategy and diversification, Greenblatt does make seveal points as to hold 5-8 well researched stocks for greater returns. For those individuals who want to put their portfolio on auto pilot, follow the magic formula as layed out in the book.
• David Dreman- Also advocates a diversified portfolio in his books. But, he made good money by placing big bets in Fannie Mae (prior to its recent  drop he bought below $5) and Altria

Pitfalls of concentration

• A more volatile portfolio.
• A blowup in the portfolio will be a major setback against the market
• You have to be VERY patient

Tools for concentrarion

• Time
• Time
• Time
• Knowledge
• oh yeah, patience

Quotes

I don’t look to jump over 7-foot bars: I look around for 1-foot bars that I can step over. – Warren Buffett

Put all your eggs in the one basket and — WATCH THAT BASKET.
Pudd’nhead Wilson, Pudd’nhead Wilson’s Calendar, Chap. 15

The fact that Bruce Greenwald is a professor at the Robert Heilbrunn Professorship of Finance and Asset Management at Columbia Business School is a must read. I stumbled across this book about four years ago when I was buying everything that was related to value investing. Even though I re-sold most of the value investing books, I kept the must reads like The Intelligent Investor, All of the David Dreman books, Joel Greenblatt’s Little Book, and a few others. I kept this book because it has its own little niche in the value investing arena, its truly a modern approach to Ben Graham and Warren Buffett. Bruce Greenwald’s 3-Step approach to valuing a company is one that a) makes sense and b) does not put too much emphasis on future growth. For those individuals that have not had a chance to read the book, Greenwald advocates a 3 step approach to valuing a company.

1. Value the assets
2. Find the company’s Earnings Power Value (EPV = Adjusted Earnings x 1/R, where R is the current cost of capital or rate of return
3. Only when the company displays a franchise can we incorporate growth into the equation

Especially during the dot-com boom, #1 (Assets) was highly ignored. Companies that had little to no assets were valued greater than a stalwart like Proctor and Gamble (PG). The beauty about investing in companies with hard assets is, if the company disappoints on in the earnings front, one can sleep conferable at night knowing the assets are there (like a safety net). Dot-com companies never had this safety net and the stock price experienced catastrophic declines when earnings disappointed. #2 can be applied to just about any company but I highly suggest looking at companies who have a history of consistency. Third on the list is factoring growth where a franchise is in place. Greenwald defines a franchise as when the firms EPV exceed the company’s Asset Value (43). Another way to think about this is what Warren Buffett calls a moat. Companies with a moat tend not to require additional investment, but can still increase its earnings (think See’s Candies, Burlington Northern). Now, Greenwald and Co. do a tremendous job in walking the reader on how to analyze a company and valuing the company using his 3 step approach ( he values WD-40 Co (WDFC) and Intel (INTC)) but the second half of the book is devoted to value investors and some of the techniques they employ.

The second half of the book profiles value investors that have outperformed the market. Greenwald devotes the most attention to Warren Buffett 9bug surprise there right?) and highlights some of Warren Buffett’s shareholder letters. Below are the value investors highlighted and the chapter title

• Warren Buffett :Investing Is Allocating Capital
• Mario Gabelli : Discovering and Unlocking the Private Market Value
• Glenn Greenberg : Investigate, Concentrate and -Watch that Basket
• Robert H. Heilbrunn : Investing In Investors
• Seth Klarman: Distressed Sellers, Absent Buyers
• Michael Price: Discipline, Patience, Focus, and Power
• Walter and Edwin Schloss: Keep It Simple, and Cheap
• Paul D. Sonkin: Small Is Beautiful, Especially When It’s Ugly

I have read this book twice, and each time I re-read the book I pick up a nugget or two. I have taken this book out of my library and have set it aside to re-read. Finally, the book is selling for 8.99 on Amazon.com and I highly reccommend it. As stated above, its definately not the easiest read, but its definately not the hardest either.

1. Leucadia a 10% Investor in Pershing Square-Reading Leucadia’s 10-k uncovered this
2. Video conference with Mr. Walter J. Schloss, CFA (direct link to windows media player -Mr. Walter J. Schloss, CFA, Walter & Edwin Schloss Associates, New York, NY (February 12, 2008) – Videoconference
3. Leucadia Files 13-d on AmeriCredit-Leucadia ownership now over 30%
4. Mark Sellers: Take advantage when good companies come to market-When Google completed its initial public offering in August 2004, the stock seemed overpriced. Even after reducing its IPO price from $108 to $85, the company’s trailing price/earnings ratio was well over 200. Journalists, analysts and market pundits exclaimed that Google was the most overpriced IPO in years, and warned investors to avoid it.
5. It’s a matter of reading and asking questions-A question Warren Buffett and Charlie Munger are often asked is: how do you learn to be a great investor? “First of all,” says Charlie Munger, “you have to understand your own nature.

But today was different. The Fast Money crew did a show on “Finding your style”, something that every investor has to go through at one point. Basically, each trader presented different ways or styles that one could make money in the market. Each trader presented what works for them. For example, Guy Adami relies on trading volume and market sentiment (whatever that means).

In a perfect world, it would be great to invest like Warren Buffett. Truth is, Warren Buffett is truly a unique individual that somehow finds a way to be a couple of steps in front of everybody. Although one can buy what Warren Buffett buys, there are drawbacks. In one quarter, Target (TGT) appeared as one of his holdings. In the next quarter, it was reduced. Even Warren Buffett had to find his style. Before becoming a value investor, Buffett tried everything, including charting. It wasn’t until he read The Intelligent Investor that “it clicked”.

Personally, I tried many different value investing styles before settling on my current style. The first contrarian investing book I read was David Dreman’s Contrarian Investment Strategies: The Next Generation. After I read that book, I bought all his other books. Next, I bought Pat Dorsey’s book and tried the almighty discounted cash flow model (DCF). While I read these books, I used Investopedia’s simulator to track my performance. I did OK but I knew I could do better. Instead of trying to be like Dreman, I started to be like Alex Garcia. The whole contrarian is in me, but I sprinkled in Greenblatt’s Magic Formula and Professor Greenwald’s emphasis on assets.

You will see this in the value investing community, where no one value investor is identical to another. Bill Miller invests in companies Warren Buffett would never touch (i.e. Amazon). Warren Buffett invests in companies Walter Schloss would never touch. Of course, I am assuming Walter would never touch a company like American Express. Why? Amex does not have the hard assets Walter Schloss likes.

How does one find an investing style?

In one word, experiment. Sites like investopedia.com and marketocracy.com allow one to experiment as much as possible without risking any money.