This article was inspired by a few recent Twitter posts by John Huber at Base Hit Investing. John is one of my favorite writers and a fan of Warren Buffett's concentrated investing approach. As previously written, I've struggled over whether to adhere more closely to Ben Graham's diversified, quantitative approach or whether to stick mainly with Buffett's concentrated, buy and hold approach.
So John Huber first posted the following tweets:
- John Huber @JohnHuber72 I am sensing a certain tone in the value investing community that I'll call "Buffett fatigue". Many are sick of hearing about Buffett's principles, "compounders", etc... I totally agree on the air time, and maybe I'm the proverbial bell at the top, but I have 2 points... (1/2)
- John Huber @JohnHuber72 "Buffett fatigue" isn't new (In 1998, Michael Burry lamented how everyone was piling into Coke at 40 PE b/c "Buffett is in it"; 2) The fact that "true value investors" are sick of hearing about compounders and the principles of Buffett doesn't diminish the merits of that approach
- John Huber @JohnHuber72 In reality, each business is worth the discounted total of what it will earn in the future. To me, it's no more or less conservative to make future earning power assumptions about a stable, no-growth company than it is for one that is currently growing.
- John Huber @JohnHuber72 I think "value" and "growth" are not mutually exclusive. They are not separate style boxes. The value of any business is not what it earned last year, it's what it will earn in the future. Whether you look at stocks at 10 P/E or 30 P/E, you're making a judgment about that future.
I then replied as follows:
- Bill Esbenshade @bill_esbenshade @JohnHuber72 Although what I love about Graham and early Buffett is that it’s algorithmic and idiot proof; low PE, low debt, etc., buy a spread of 20+ positions, and pick a simple sell rule; this approach produces excellent results based on extensive back testing (and personal experience)
- Bill Esbenshade @bill_esbenshade @JohnHuber72 Buffett’s find a moat, concentrate, & buy & hold approach requires good judgment and strong emotional resilience; it’s emotionally tough and hard to stick with because my judgment could be wrong, resulting in opportunity costs I don’t want to incur over my limited lifespan
This Twitter exchange caused me to jot down some thoughts about luck, opportunity costs, and the goal of minimizing luck and opportunity costs:
- Graham’s quant approach involves: (1) application of a screening formula; (2) selection of a diversified portfolio of 20+ stocks; and (3) adherence to a mechanical sales rule.
- Buffett’s concentrated approach isn’t mechanical and depends on the investor’s subjective judgment of whether a company has predictable earnings and a sustainable competitive advantage. A Buffett-style investor may feel certain of his judgment, but he can still be wrong due to unanticipated future events — also known as bad luck. If a concentrated investor is wrong his investments will underperform.
- Graham’s diversified, mechanical approach isn’t based on subjective assessments of whether a company has a sustainable competitive advantage — it works regardless of the investor's judgment and the possibility of misjudgments or unanticipated events. On a diversified, portfolio basis, Graham’s approach minimizes the impact of bad judgment or future bad luck.
- All this raises the question: if I’m reasonably assured of good long term returns with Graham’s mechanical quant approach (based on extensive backtesting by multiple authors including Ben Graham, Tobias Carlisle, Joel Greenblatt, James Montier, etc.), then why would I jeopardize these reasonably assured good returns — and risk incurring unrecoverable opportunity costs over my limited lifespan -- by following a concentrated approach that depends on subjective, accurate assessments of sustainable competitive advantage?
The author is not an investment advisor or CFA and readers should consult an investment advisor before buying or selling any publicly traded stock. The views expressed in this article are the author's personal opinions and should not be construed as investment advice.