Concentrated Investing (by A Benello, M Biema and T Carlisle) | Best Investing book | Stock market

Jun 21, 2021 11:30 · 3747 words · 18 minute read

The most asked question by people investing are What are the ideal number of stocks in your portfolio? And how much should you allocate to each one? Should it be 2 stocks with 50 percent in each stock? Or should it be 100 stocks with 1 percent each? Diversification is a very common term used in investing, which means dividing your total money in different investments.

00:24 - Most of the mutual fund and hedge fund owners have more than 50 stocks in their portfolio, and not taking more than 3 to 5 percent position in any company.

00:29 - Even most of the retail investors on an average has between 30-50 stocks in their portfolio.

00:41 - People think, that way they have diversified the risk.

00:44 - Which is mark of a great investor. After all one of the most common jargon you will hear is Do not put your eggs in one basket.

00:52 - You will be surprised to know that most of the great and wise investors who have experience of half a century in stock market, not only them but even the top 1 percent richest people in the world of the like of warren buffet, Charlie munger, Elon Musk, Jeff Bezoz, Mukesh Ambani and many others made their fortunes by concentrating their portfolios around very few investments with number of stock in their portfolio, ranging from 1 stock to 15 stock.

01:21 - Where everyone around preaching us the idea of diversification with the maxim of Don t put your eggs in one basket , these have done just opposit, maybe not one, but they have definitely put their eggs in very few baskets and then watched the basket very carefully.

01:38 - Concentration value investing is a little?known method of portfolio construction used by famous value investors Warren Buffett, Charlie Munger and others profiled in this book to generate outsized returns.

01:47 - A controversial subject, the idea of portfolio concentration has been championed by these investorsr for years, although it moves in and out of fashion with rising and falling markets.

01:50 - When times are good, portfolio concentration is popular because it magnifies gains; when times are bad, it s often abandoned after the fact because it magnifies volatility.

01:56 - It is time to re?visit the subject of bet sizing and portfolio concentration as a means to achieve superior long?term investment returns This is the better investor, helping y ou achieve your financial goals and freedom through organizing your finance, stock market investing and learning from billionaires.

02:16 - And these are top 5 lessons from the book Concentrated investing stratergies written by Allen C Benello, Michael Biema and Tobias Carlisle Lesson number one How legends managed their money? Before we move on to draw any conclusion that in how many companies you must invest, we must first learn how most noble investors and businessmen made their or their companies fortune.

02:46 - Lets take them one by one as mentioned in the book.

02:48 - No. one Lou Simpson Lou Simpson was Chief investment officer at GEICO, which is an insurance company, which Warren Buffets who is known as the worlds greatest investor purchased through his insurance company Berksire hatchway.

03:05 - This process of a large company buying a small company is called acqusistions.

03:10 - Warren Buffet calls GEICO as one of the best and most important investments ever made by him.

03:17 - Even though GEICO was acquired by Berkshire Hathway, but Warren Buffet did not change people in its management, and to your surprise Lou Simpson s record at Geico from 1979 to 2010 rivals that of Buffett at Berkshire Hathaway, but he remains little-known, except by true Buffett fans.

03:40 - In 1970 s and even today many insurance companies held a diversified portfolio of fixed income securities, bonds etc. conting on diversification to minimize risk. GEICO was o different till Lou Simpson took over.

03:58 - As he came he put 10 percent of geicos portfolio in stocks which was just 5 percent before.

04:05 - In 1982 GEICO has 280 million dollar of their insurance money in 33 stocks, he then cut it to 20, then 15 and the nuber of stocks then remained between 8 and 10.

04:22 - In 1980 s GEICO had 6 electric utility companies out of 10.

04:27 - Simpson would take those big bets only when he thought the odds were well in his favor.

04:32 - To tell you about his track record, his annual average return from 1980 to 2004 is 20. 3 %per annum where the index gave just 13. 3 % per annum.

04:49 - John Maynard Keynes, a trader turned investor and an investment officer in UK s insurance company in early 20th century.

04:56 - What Lou Simpson was to USA, John Maynard Keynes was to UK.

05:01 - When Everyone in UK held just 3 percent of the insurance float in stocks, Keynes, changed and allocated more than 75 percent in stocks.

05:09 - 50 to 75 percent of his stock holdings Was just in 5 to 10 stocks.

05:14 - With two third of this money would be in one particular industry.

05:18 - According to the book from 1930 to 1934 he had 50 percent of his holdings in just two automobile manufacturer Austin Motors and Leyland.

05:28 - His grew his investment fund from 1927-1940 at the rate of 13 percent per annum when the UK s equity market gave negative returns of one percent.

05:40 - An outperformance of 14 percent. How can we talk about investors and not Warren Buffet.

05:47 - Before Warren buffet bought into Berkshire Hathway.

05:50 - He ran his own investment fund. In 1964 he had 40 percent of his funds money in just one stock that is American Express.

06:01 - Before that in 1959 he had 35 percent of his money in Sanbornes map.

06:09 - Even today more than 42 percent of Berkshire hathhway portfolio is in just one stock that is Apple.

06:21 - Buffets right hand man Charlie Munger also ran his investment fund called wheeler munger partnerships from 1962-1975.

06:28 - Which returned annual return of 20 percent within this period, where the US S&P 500 index gavejust 5 percent.

06:39 - And Outperformance of 15 percent. The number of stocks in his fund were just 3.

06:50 - Kristian Siem a billionair value investor from Norway, made all his money buy buying into Oil refining Oil exploration and Shipping companies whenever there was pessimism about oil prices and sold them when everyone was optimist.

07:09 - That is how he made his fortune. 2.

07:13 - How wealth is made? A highly diversified portfolio will have all the companies listed on stock exchange and every company having equal allocation.

07:25 - That means 5000, but fir this example lets just consider 100, so one percent each in 100 stocks.

07:39 - And the highy concentrated portfolio of stocks would mean just one stock and putting all your money to it.

07:46 - If you expect the profits of the company in your concentrated portfolio to double its profits in coming 3 years then most likely the stock price would also double.

07:56 - And that is all you need to double your money.

07:59 - However in our diversified portfolio, if you would want to double your money then, all the 100 stocks must double their profit in 3 years, which is very difficult, because there aren t so many great businesses which can achieve that.

08:13 - Its just like tossing a coin and expecting it to give heads everytime.

08:14 - However if any one stock doubles then that will have no effect in your portfolio, just that your 100$ invested would now be 101$.

08:22 - So it is pretty evident that a portfolio of just one carefully selected stock about which you know everything about, about whose business you have an insight will outperform the diversified portfolio in which you have just put equal money.

08:39 - All of the richest people in the world, created their wealth this way.

08:43 - Jeff Bezoz had more than 99 percent of his networth in the stock of Amazon, Obviously because he was the CEO and who else would know about his company more than anyone.

08:55 - A similar question was asked to warren Buffet in his shareholders meeting, as to how many stocks does he own in his personal portfolio.

09:03 - And he said he just owns one stock, and that is of Berkshire hathway of which he is CEO of.

09:11 - The reason that almost all of the wealthiest people are businessman is because almost all of their networth or money is invested in their own companies, about which they know almost everything about.

09:23 - This leads us to a very important conclusion, that the path to creating enormous wealth lies in concentration and not diversification and that all the people who have made it to the list of the richest have done it through concentration and not diversification.

09:37 - 3. How many stocks to own? As said above that giant wealth creation is done by concentrtation and not diversification, so is it the best idea to put all your money in one stock just like warren buffet has his personal holdings? Well not.

09:56 - First of all average investor is not the promoter or manager of a business, thus he would never know about a business as much as a manager knows about it.

10:07 - Though this is no excuse for not studying about business of ones company in depth, however still there is always a room left for the error of judgement.

10:16 - Too Err is human, and for this reason if you go wrong on your analysis on your one stock which is the only stock in your portfolio, you would end up loosing all your money.

10:28 - Just as simple and easy it looks to create wealth in concentrated portfolio, it is as easy to loose it too.

10:35 - However in our 100 stock portfolio, even if a single company goes to xero, that would just reduce your holdings from 100$ to 99$.

10:44 - To loose all your money in a diversified portfolio all of your stocks must go down to zero, which is higly unlikely.

10:53 - Thus we reach to one more conclusion, that a carelessly selected concentrated portfolio is at higher chances of destroying your wealth than an average 100$ diversified portfolio.

11:07 - Thus for a know nothing investor, who does not have time to read about businesses, talk to its employees, read and understand financial statements of a company.

11:17 - The best option for him will be a diversified portfolio, because his lack of time and interest would never let him have true and justified conviction about one particular business.

11:30 - Thus concentrated investing is not for him, and thus the know nothing investor must also then not try to have above average returns, he must be satisfied with mediocre and average results.

11:43 - Even the greatest investors and the great companies all practice diversification, because they know that even though they know everything abut the company, still there may be events which may happen in our world about which we never thought of, which can damage the survives.

12:02 - But mind you again, the diversification does not mean selecting 50 such stocks.

12:06 - But rather diversifying into 3 to maximum 15-20 stocks.

12:10 - One of the greatest Indian business tycoon Mukesh Ambani, who is the richest Indian in the world, may just have one stock in his portfolio which is Reliance, but reliance itself has diversified its business into oil refining, tele communication, retail and media.

12:27 - So he may be owning just one stock of reliance from far, but you go closer he owns these other businesses as well.

12:35 - Similarly Warren Buffet in his personal portfolio may be owning just one stock that is Berkshire Hathaway.

12:41 - But the insurance company Berkshire Hathaway itself has investments in other companies like apple, coca cola etc.

12:49 - So just owning many number of stocks is not diversification, but owning just one stock of a business which is already diversified maybe good enough diversification.

13:01 - Lesson number 4: Fluctuation in stock price is not risk One of the greatest learning which all the great investors preach is that the daily fluctuation of stock price is not risk at all, which most of the people think.

13:14 - All the great investors, appreciated fluctuations as they gave these people chance to buy the stock of the company they like if by any chance the price dropped suddenly for no reason at all.

13:25 - They believed that the only risk a value investor may be worried about is the risk of permanent loss of capital.

13:32 - However if you see risk as the deviation from the average, then the study by Elton and gruber in 1977 is very famous in investing and is also mentioned in the book.

13:44 - It suggests that as the number of stocks in a portfolio increases, the deviation or the fluctuation in overall portfolio reduces.

13:52 - Which means that a portfolio of one stock will fluctuate more than the portfolio of two stocks, and as the number of stocks increases, the fluctuation reduces.

14:04 - As you can see, from this chart, the fluctuation reduces considerably as we keep on adding stocks, upto 20 stocks and beyond than even if we increase it to 1000 or infinity, there is hardly any change from the fluctuation that we were seeing with our 15-20 stocks.

14:22 - Thus even if we consider fluctuation as risk, even then going beyond 15-20 stocks in ones portfolio is of no significant use, keeping in mind, how much more you would have to read about these companies, in limited 24 hours that a human has in his day.

14:40 - Thus Most of the great investors kept themselves within this bracket of 3 to 15 stocks.

14:46 - Charlie Munger, the vice chairman of Berkshire hatchway, the right hand man of Warren Buffet, just had 3 stocks in his portfolios and he said that it is highly unlikely that in a portfolio of 3 very carefully selected stocks, all three will go bust together, and that is good enough diversification.

15:06 - Lesson number 5 : The Kelly s Formula. After we are clear the effects of diversification and concentration, and how many stocks in the portfolio is good enough, the most important lesson from the book is that how concentrated should you be on any one stock.

15:22 - Which means if you own 5 stocks, then should you just put 20 percent equally in each.

15:27 - or 10 in some and 20 in some. Kelly formula is a mathematical formula used in probability, however lets not get mathematics in it.

15:37 - What Kelly formula means is that whenever an investor has superiors insight or surety that the chances of success of a particular business is high, then the amount of money you must invest in it must be much more.

15:54 - Which means in a portfolio of 5 stocks, you must put the most and biggest amount of money in the stock that you are most confident about.

16:03 - Warren Buffet said that it is a foolish idea to put your money in your 20th best idea Let us understand this with a small though experiment Suppose there is a betting house where there are two bets playing.

16:17 - The first bet. A person tells you in the month of extreme summer in the deserts of thar, to predict whether it will snow in the coming week or not and he tells you that if you get it right, you take home ten times your money and if you get it wrong you loose it all.

16:34 - The second game is to predict in the same summer moth in the thar dessert whether the temperature will cross 30 deg Celsius by 9 o clock in morning.

16:44 - How much percentage of money would you spend and on which bet.

16:48 - Obviously, your answer must be first bet, because the chances of snowing in a summer month in a desert is zero in the coming week, we do not know what will happen after 10000 years later but for now you can be 100 percent sure that you will win the first bet, and not look at any other bet and thus you must put 100 percent of your money in the first bet, and if you are a fan of leverage, then you can take as much as you want, because you will not loose.

17:17 - However you cannot do the same thing with second bet, first of all if these are the only two bets available, then you must not even look at this bet.

17:26 - So using Kelly Formula, an investor knows that he must concentrate his money in the companies stock about which he has great insight and confidence on.

17:36 - In 1959, American Express name had come in a very famous scandal of that time called the Salad Oil Scandal, and market was punishing the stock price.

17:48 - When Buffet got a hint of it, he quickly called up all the customers, read about the business and found out that the company is great and the news reports were nothing but false acquisitions and media rumors’.

18:06 - And even if the scandal was real, the company had a good business, which in the long run would not be affected by a scandal.

18:12 - Buffet then ran a fund called Buffet Partnerships.

18:13 - He then put 40 percent of the funds money in American Express, the price grew hundered folds in next 20 years.

18:21 - Thus when such opportunity shows up to you where the chances of your losing is negligible, you must pile on your money in that investment.

18:29 - Thus we come to another conclusion that there is no statistical formula which can tell you how much of money should be put in which company, but in a very subjective way Kelly Formula tells us that the biggest part of your investment must be in a company s stock about which you are most confident about and no money must be put on a stock where chances of you winning is less than 50 percent no matter how big the reward.

18:58 - For this we must not forget the words of warren buffet During the Penalty shoot out, the football team captain has to choose the top five players on whom he is most confident about to hit the ball in the goal.

19:13 - Investing is no different. Lets have a quick recap: 1.

19:18 - There are many smart money managers, but very few of them who outperform the market returns for a very long time.

19:24 - One of the most important trait of these great money managers was that they held very few stocks.

19:30 - And these were those on whose prospects they were most confident about 2.

19:34 - The path to create humongous amount of wealth is concentration.

19:37 - A carefully selected single stock portfolio will putperform a diversified portfolio 3.

19:44 - A carelessly selected concentrated portfolio is most likely destroy al your wealth than a diversified one.

19:51 - Concentration can be dangerous if not done in the right way.

19:54 - So for a know nothing investor, who do not aspire to read about a business it is in his best interest to diversify his investments, also such kind of investor must be happy in average market returns and must not try to bag above average returns.

20:02 - 4. Fluctuation of stock price in markets is not risk, the real risk is permanent loss of capital.

20:07 - All great investors saw fluctuations as an opportunity to buy their favorite stock at cheap price.

20:14 - However even if we consider it as risk, we come to know that the fluctuation in portfolio reduces as we increase the stocks from 1 to 15.

20:22 - Owning more than 15 stocks have no practical impact on controlling the fluctuation, which comes at the cost of reading more about these companies, which may be a burden on attention and mental peace of an investor 5.

20:35 - The amount of money that you must put in one stock must be directly proportional to the confidence you have in the prospect of the company behind the stock.

20:43 - The better the prospects the higher the money in that stock.

20:46 - All these investors beat the index because they invested only when they were completely satisfied and confident about the business they were investing in. Rest all the time they did nothing and waited patiently.

20:52 - Investing to them was like a football penalty’s shootout, they only selected the best players to score a goal.

20:55 - As I end this episode I am reminded of very wise words of Charlie munger mentioned in this book he says It s not given to human beings to have such talent that they can just know everything about everything all the time.

21:09 - But it is given to human beings who work hard at it who look and sift the world for a mispriced bet that they can occasionally find one.

21:18 - And the wise ones bet heavily when the world offers them that opportunity.

21:23 - They bet big when they have the odds. And the rest of the time, they don t.

21:28 - they do nothing, It s just that simple. That s it guys if you liked the video please like share and subscribe.

21:36 - You can also watch my video on financial euphoria’s of past which is a very interesting read.

21:41 - I will come again with the lessons on some other investing book soon, until then cheers guys!.