Editor's note: Today we're sharing an important essay that will help you become a much better investor. It's a timeless piece by Bonner & Partners analyst Chris Mayer.
If you've never heard of Chris, he’s one of the best stock pickers in the business. From 2004 to 2014, he beat the S&P 500 by more than 3 to 1. He outperformed Warren Buffett's Berkshire Hathaway (BRK) by 2 to 1.
Here's why his investing style works…
The investing style I embrace is controversial.
It’s a hidden strategy used by many of the winningest investors in history. Yet most of the so-called stock-picking experts in academia, media, and brokerage offices will tell you to do the exact opposite of what makes this strategy so successful.
They write articles, books, and research papers about how you shouldn’t follow this investment method. They even rant about it on TV, radio, and the internet.
But the truth is, behind closed doors, the top traders, investment banks, and hedge funds are using one simple strategy to make billions in profits every year… all while telling you it’s a bad idea.
Now, in a new book called Concentrated Investing, Allen Benello, Michael van Biema, and Tobias Carlisle bring this guru strategy out into the open… and reveal how it delivers such extraordinary results.
The basic idea is that a portfolio of 10 to 15 stocks can far outperform a widely diversified one.
The book includes profiles of investors who ran such concentrated portfolios. Below are my notes on a few favorites: Lou Simpson, John Maynard Keynes, and Claude Shannon.
Lou Simpson: How an Investor Should Act
Simpson ran GEICO’s investment portfolio from 1979 to 2010. His record is extraordinary: 20% annually, compared with 13.5% for the market. His five key strategies are these:
Invest in high-return businesses run for the shareholders,
Pay only a reasonable price, even for an excellent business,
Invest for the long term, and
Do not diversify excessively.
On the last one, Simpson writes: “Companies that meet our criteria are difficult to find. When we think we have found one, we make a large commitment.”
Simpson’s focus increased over time. In 1982, he had 33 stocks in a $280 million portfolio. He kept cutting back the number of stocks he owned, even as the size of his portfolio grew. By 1995, he had just 10 stocks in a $1.1 billion portfolio.
But he did not just buy and hold. Simpson would add to a holding if it fell (and thus became more attractive). He would trim it back if it got pricey. A good example is how he handled his stake in Nike.
Over a 20-year stretch, there was never a time Simpson did not own Nike. When the price reached over 20 times earnings and there were good alternatives, he’d pare it back. When it got down to 13 times earnings, he’d add to it. At one point, it was 16% of his portfolio.
Simpson didn’t sell because the stock price fell. He based his buy and sell decisions on valuation.
Another important aspect of Simpson’s record: He did not trade much. There was very little turnover. He said you only need one, two, or three good ideas a year once you’re fully vested. “We do a lot of thinking and not a lot of acting. A lot of investors do a lot of acting and not a lot of thinking.”
John Maynard Keynes: Successful Through the Great Depression
Keynes is famous as an economist, but early in his career, he speculated on currencies and commodities. This risky approach cost him all of his money in the early 1920s. And he nearly lost it all again after the Great Crash of 1929.
After this, he changed his approach. He began to think about stocks as businesses with an underlying value apart from the quoted stock price. He began to hold on to stocks longer. Typically, five years. He often continued to buy them if they fell lower.
He also came to love focusing his portfolio on fewer names:
As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one’s risks by spreading too much between enterprises about which one knows little and has no reason for special confidence…
He made his reputation as a money manager running King’s College endowment. His Chest Fund sometimes had half of its money in just five stocks. In 1933, he had two-thirds of his portfolio in South African mining stocks.
His results were spectacular. The Chest Fund (1927–1945) grew fivefold while the UK market fell 15% and the U.S. market fell 21%.
He offered up the best summary of his own approach in 1938:
A careful selection of a few investments (or a few types of investments) having regard to their cheapness in relation to their probable actual and potential intrinsic value.
A steadfast holding of these in fairly large units through thick and thin, perhaps for several years, until either they have fulfilled their promise or it is evident that they were purchased on a mistake.
A balanced investment position (i.e., a variety of risks in spite of individual holdings being large).
Claude Shannon: The Power of Rebalancing
Shannon was a brilliant mathematician who made breakthroughs in a number of fields. He might also be the greatest investor you’ve never heard of.
From the late 1950s to 1986, he earned 28% annually. That’s good enough to turn every $1,000 into $1.6 million. What I want to highlight here though is an investing method he wrote about later called “Shannon’s Demon.”
It goes like this: Imagine a portfolio of $10,000 with 50% in cash and 50% in one stock. The idea is that you will always keep this portfolio at 50/50 by rebalancing every day.
So, let’s say the stock falls in half after the first day. Now you have $7,500. You have the $5,000 in cash and $2,500 in the stock. You re-balance. Now you have $3,750 in cash and $3,750 in that stock.
Next day, the stock doubles. Now you have $11,250. Your portfolio is up $1,250, even though the stock has gone nowhere. You rebalance again. The stock gets cut in half… If you repeat this pattern, the portfolio will be worth $1.1 million at the end of 80 days.
The assumptions are not realistic, but they make an important point. As the authors of Concentrated Investing point out:
[The gain] occurs even though the stock hasn’t budged – it’s still at its starting price – and a buy-and-hold investor in the stock would have no gain… The rebalancing forces the investor to buy stock at the low, and sell at the high.
Most investors do the opposite.
In my newsletters, we focus on small groups of select stocks. We add to our favorites when the market gives a chance to own them cheaper. We trim them back when the market gives us a good price. And we focus on position size.
Editor’s note: This week, Chris is holding an investment masterclass, which—for a limited time—you can access for FREE.
In a series of short training videos, Chris reveals the breakthrough investment method he’s spent the past three years and more than $138,000 developing…
This method will help you build a focused portfolio of companies with “Apple” potential—the kind of portfolio that can create a fortune for you with just one win.
And to prove to you how well this strategy works, Chris will share six stocks from his Watchlist with you for free.
Training starts today and culminates in an extended masterclass Thursday night at 8 p.m. To make sure you don’t miss a minute, please register your email now by clicking here.