“Diversification is protection against ignorance. It makes little sense if you know what you are doing.” Warren Buffett
Mr. Buffett has a way with words, and has clearly earned respect for not only accumulating massive wealth but for his folksy wisdom. But combine the above with his “Diversification may preserve wealth, but concentration builds wealth”, and you have a worldview that may work for Warren but is terrible advice for most Americans who simply want enough money in retirement to meet their spending needs.
Here’s where we think his business partner Charlie Munger’s advice is a far more useful lens:
“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”
Let’s think about this through the lens of the current market. It seems many want to make a call on a rotation from growth to value, or large to small, or whatever label one wants to throw on the battling themes of “overpriced” and “due to recover”. The reality is that while the COVID stocks dominated the early lockdown period, since May we’ve seen 1-3 week spurts of one side crushing the other. Should we care?
If our approach is to make a bet on vaccines, and elections, and the global economy, then maybe the answer is “Yes”. But if we can simply follow Charlie Munger’s advice, there is zero need to guess the end date of COVID or the top for Amazon or bottom for American Airlines. There are so many better ways to confidently move forward in this noise-filled market.
Forget the Fed, forget the election, forget the date of the first vaccine. What can we actually know? How about starting with these questions about anything we own:
- Does the company generate positive cash flow? Is that cash flow stable, maybe even growing?
- Does it generate returns exceeding their cost of capital?
- Is it adequately funded to support operations?
- Could it raise extra capital if an opportunity came along?
- Does it run with enough flexibility to pivot in a hot-and-cold economy?
- Is it holding market share in a growing sector, or taking share in a stagnant one?
If the answer is “Yes” to all of the above, we may have ourselves a candidate for ownership! And in an environment where junk bonds yield 3%, a company with an earnings yield of 3% that can actually grow might indeed be worth the 30+ earnings multiple that has kept “value investors” away. That said, price DOES matter, and if we pay 60x for that same business (1.6% earnings yield) then we’ve likely forfeited years of total return potential.
The bulk of our work lies in the business questions, with valuation a factor after we’ve decided what businesses we’d even consider owning. We respect the work that goes into true value investing, but most of what’s publicly discussed is either too obvious (price is cheap!) or too hard (it will turnaround!) for us to try buying perfectly…and selling perfectly, which is often required when shopping in the “cheapest stocks” bin.
Picking sides on short-term events is an awfully hard way to make money. So is worshipping single “factors” like value or size or momentum. We put our emphasis on a more general approach that’s not reliant on being consistently brilliant:
- Own what we consider great companies across many sectors, factors, and return drivers
- Think hard about the position sizes that can be comfortably held
- Be aware but not obsessed with valuation, especially if new growth is possible
- Build in a small layer of market protection that can be a source of buying power in a market crisis
Warren Buffett is wired perfectly for investing success, but it’s not because he chose to bet on value or growth. Much of his fortune has come from a simple confidence in American business and, at Mr. Munger’s urging, the realization that growth is a key component of discovering value. To his credit, he left cigar-butt investing behind and figured out how value and growth can build upon each other.
Back to the context of the current mixed market…is it important for you to know the outcome of the next few months of elections and COVID and whatever becomes the next headline event? Or is it more important to have a consistently executed plan that considers all outcomes, good and bad, within the context of a) protecting what you have and b) grabbing opportunities that come along the way?
We prefer to keep an open mind vs. picking sides, but in this case we think Mr. Munger’s wisdom is the one to etch into our brains.
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