“Invert, Always Invert.”
-Carl Gustav Jacob Jacobi, 19th century mathematician, using the phrase to describe how he thought many problems in math could be solved by looking at the inverse. Charlie Munger often uses this same quote to express how investors can likewise benefit by looking at the inverse, or opposite, of what others are looking at.
Yesterday I wrote a post on Buffett and how he achieved 50% returns, and “guaranteed” that he could replicate those returns on a smaller amount of investment capital. Many other investors have achieved these types of returns in the past in their early years of managing just their own money, or when their funds were small. Joel Greenblatt made triple digit returns in his early years with his own money (according to his interview in Market Wizards), and then famously averaged 50.0% per year for 10 years while starting with $7 million of investment capital in his fund. Many other investors, most of whom the average person hasn’t ever heard of, have also achieved huge returns.
I’ve always thought that is is extremely beneficial to study the patterns and investment styles of these types of investors. How did Greenblatt do it? How did Buffett make 60% returns for a few years in his early 20’s? How did Ahmet Okumus achieve 100% returns for a decade, and then 30% returns in his fund? How did Mohnish Pabrai achieve similar returns with his own capital and subsequently for his partners’ capital?
As I said in yesterday’s post, they did this by thinking differently. As Munger said, they “inverted”.
Invert, Always Invert
I’ll mention two basic portfolio management tactics that are accepted as central principles that value investors might want to consider inverting. These are:
- Diversification vs Concentration
- Turnover (the idea that it’s better to have low turnover)
That foundation I described in the first few paragraphs of this post is sufficient to build a long term successful investment career. But let’s invert for a minute… Graham made most of his money in Geico, a growth stock. And Graham also once said (in the Intelligent Investor of all places) that one should diligently grind out a methodical approach based on value, day after day, year after year, but should also always be on the lookout for an opportunity to invest big when all the stars line up (I’m paraphrasing of course). Graham invested about 20% of his entire fund into Geico, and it quickly became a much larger position than that. In fact, Graham made more money in Geico than all of the other thousands of investments in his entire career, combined.
Now, this Geico investment came after years of building a successful investment career, achieving consistent 20% returns for decades. Walter Schloss achieved similar results, and in his early years achieved 30% annual returns for many years, and Schloss never had a “Geico” moment. He simply invested in around 1000 companies during the course of his career, holding between 50 and 100 at any given time. So it’s not necessary to hit a home run like Graham did, but it doesn’t hurt to grind out steady base hits and be prepared for the fat pitch over the heart of the plate. If that pitch comes (i.e. a high conviction idea that carries very little risk of permanent capital loss), taking a large position can benefit the investor.
Most of the investors above who achieved these 50%+ annual returns all believed that concentration has its benefits.
This is a topic that is even more misunderstood by most value investors. Buffett is famous for saying his favorite holding time is forever. But this wasn’t always the case. Buffett even sold his “security he liked best” (Geico) in order to invest in even more undervalued stocks, selling them as they appreciated, and repeating the process. His turnover was much higher in the early years, and so were his returns.
If you have an edge, a multiplicity of transactions increases returns. The reason that low turnover is accepted as common place, is that most individual investors don’t have an edge, so trading more will end up costing the investor more, in terms of returns, commissions, and taxes. Don’t misunderstand, I’m not a proponent in trading often. But if you have an edge like Buffett or Greenblatt, you might be able to achieve higher returns by buying undervalued stocks, patiently holding them, and selling them when they appreciate, and repeating the process. The holding period might be a year or more, just not “forever”.
To Sum it Up
Now, here at BHI, I’m a big fan of doing simple, methodical things that can easily be replicated. I’m a proponent of Ben Graham, and my ideas on the investment process are probably most similar to Walter Schloss. So I lean toward diversification and low turnover, long term, value oriented thinking. But like Michael Burry once said, you have to take what you’ve learned and then make your own style. Pabrai says to simply clone other investors, and I like that concept, but I would say that even that is a unique style in an of itself.
In my own investing, my foundation is Graham and Schloss, but it’s a synthesis of everything I’ve learned over the years. All knowledge is cumulative.
One of my main goals on this site is to communicate my ideas in an effort to help individual investors, who would behoove themselves by adopting a very simple investment method using the principles of Graham and the investment and portfolio management process of Walter Schloss. Add in the vast amount of wisdom from Buffett’s writings, and a few important quantitative inputs from Greenblatt, and you basically have my overall investment framework. But the foundation is Graham, specifically: buying cheap stocks automatically gives you an edge.
I’m not necessarily saying that concentration is better than diversification, or turnover is better than holding forever, but I am suggesting that inverting your thinking will help your results. As John Templeton said, “If you want to have a better performance than the crowd, you must do things differently from the crowd.”
Invert, Always Invert…. in the next part I’ll list the main mathematical aspects of investment returns.