Tuesday, July 14, 2015

Buffett & Munger: Embracing the Unconventional

"Develop your eccentricities while you are young. That way, when you get old, people won't think you're going ga-ga." - David Ogilvy

Historically, Berkshire Hathaway (BRKa) has often held -- especially when compared to the norm among professional investors -- a rather concentrated equity portfolio.*

To say anything less would be a gross understatement.

In fact, having sixty percent or more of the Berkshire portfolio in just five stocks has been not at all uncommon.**

At times the portfolio has been even more concentrated. In the 1980s and early 1990s Berkshire's top equity positions frequently made up eighty to ninety percent plus of the portfolio.

1987 was one of those years.

Here's how Warren Buffett explained their approach in the 1987 Berkshire letter:

"...our insurance companies own three marketable common stocks that we would not sell even though they became far overpriced in the market. In effect, we view these investments exactly like our successful controlled businesses - a permanent part of Berkshire rather than merchandise to be disposed of once Mr. Market offers us a sufficiently high price."

It's portfolio concentration combined with a very long holding period.***

"A determination to have and to hold, which Charlie [Munger] and I share, obviously involves a mixture of personal and financial considerations. To some, our stand may seem highly eccentric."

In the letter Buffett writes, referring to the quote at the beginning of this post, that they've "long followed" the advice of David Ogilvy and went on to explain their attitude the following way:

"...in the transaction-fixated Wall Street of recent years, our posture must seem odd: To many in that arena, both companies and stocks are seen only as raw material for trades.

Our attitude, however, fits our personalities and the way we want to live our lives. Churchill once said, 'You shape your houses and then they shape you.' We know the manner in which we wish to be shaped. For that reason, we would rather achieve a return of X while associating with people whom we strongly like and admire than realize 110% of X by exchanging these relationships for uninteresting or unpleasant ones."

Similarly, Charlie Munger once said the following:

"...Warren and I do more reading and thinking and less doing than most people in business. We do that because we like that kind of a life. But we've turned that quirk into a positive outcome for ourselves."

It's not always about maximizing returns.

There's nothing wrong with embracing what's a bit unconventional when comfortable with the reasons why. On the other hand, simply being different for different's sake might prove expensive or, at the very least, a distraction.

The kind of portfolio concentration practiced by Berkshire, for example, is certainly not for everyone.

More from the Berkshire letter:

"We really don't see many fundamental differences between the purchase of a controlled business and the purchase of marketable holdings such as these. In each case we try to buy into businesses with favorable long-term economics. Our goal is to find an outstanding business at a sensible price, not a mediocre business at a bargain price."

The need for a huge discount to intrinsic value is more a bonus than a necessity for the highest quality businesses.

In other words, the margin of safety that's required -- while still crucial -- can be at least somewhat reduced when an enterprise has a tough to dislodge competitive position and sound long run core economics.


Long position in BRKb established at much lower than recent market prices

* The views of Warren Buffett and Charlie Munger on diversification was covered to an extent in the previous post. Berkshire's
 equity portfolio remains concentrated in its top positions but, due to the company's current size and breadth (including the controlled businesses), it is necessarily rather more diversified overall these days.
** See Table V of a study with the title "Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway".
*** One of the three common stocks mentioned is now a Berkshire controlled business (GEICO). As for the other two stocks: Capital Cities/ABC, Inc. was acquired by Disney (DIS) back in the 1990s, while The Washington Post Company has become Graham Holdings (GHC) with Berkshire reducing its stake last year after decades of ownership. Inevitably, no matter how long the intended holding period happens to be, corporate actions, changes to the competitive landscape, and other events will end up having an impact on the actual holding period. 
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