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Working with Small Sums

March 22, 2013 | About:
“Size is the anchor or performance. There is no question about it. It doesn’t mean you can’t do better than average when you get larger, but the margin shrinks.” -Warren Buffett

Contrary to what you’ve heard … size matters. Especially when it comes to investing.

Warren Buffett was once asked what approach he would take if he were managing millions instead of tens of billions of dollars. Would he invest in more Graham-type stocks—low P/E stocks—or large franchise stocks, as he is currently doing?

Buffett responded that he would be more inclined to invest in “what you might call Graham stocks.” He continued by saying he would do “far better percentage-wise” if he were working with a small sum of money.

That’s a bold statement coming from a person who has been able to compound money by 20% per year for almost half a century! Buffett told a magazine reporter, “I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”[1]

The reason he is confident that he would have better returns managing small sums of money is because of the opportunities available to him. Instead, as a large-sum investor he is faced with “relatively few possibilities in the investment world that can make a real difference in our net worth.”

The small-sum investor has “thousands and thousands of potential opportunities” while the large-sum investor has a much narrower universe to select from. Buffett concluded by saying, “So, you have a huge advantage over me if you’re working with very little money.”

When Buffett started managing money in the 1950s, he wasn’t buying large-cap multinational companies like Coca-Cola and Johnson & Johnson. Instead, his portfolio was filled with companies he found while leafing through the pages of Moody’s Manual. He was looking for stocks that were statistical bargains. His portfolio was filled with stock such as Western Insurance Securities, Grinnell Corp. and the textile company Berkshire Hathaway (BRK.A)(BRK.B)

The only thing these stocks had in common was that they were all purchased at cheap valuations to the underlying worth of their business.

His results, when he managed small sums in his Buffett Partnership (BP), were truly amazing. From 1957 through 1968 the Dow Jones annual compounded rate was 9.1%, compared to BP’s limited partner’s return of 25.3%. Over a 10-year span, Buffett, working with relatively small sums of money, was able to almost triple the Dow Jones return … and he never had a losing year.

The majority of investors, unlike institutions and large hedge funds, have no limitations on what they can buy.

By not managing large sums of money, most investors are able to take advantage of Mr. Market’s mispricing and add high-quality companies purchased at bargain prices. While many large-money managers might have seen the same opportunities, they weren’t able to invest in them.

A money manager, with $2 billion of assets under management, has a much more limited universe to invest in than we do. If the minimum investment they would make in any one stock were 5% or $100 million, they would only be able to select from stocks with a market cap greater than $2 billion. Otherwise they would find it difficult to buy or sell shares due to their size.

Where Institutions Can’t Tread

Small-cap stocks (less than $2 billion in market cap) are not as widely followed by Wall Street analysts. Since large-money managers can’t invest in them and would not generate any trading commissions for the brokerage firms, analysts focus elsewhere.

Their loss is our gain.

Here are a few companies with market caps less than $2 billion that have strong balance sheets and are currently trading at bargain prices:

Stock Ticker 3/21/13 Price P/E EV/EBIT SE/TA Market Cap
Cirrus Logic, Inc. CRUS $22.83 10 7.8 0.80 $1,499
Mantech International Corp MANT $26.38 10 4.5 0.63 $983
Cray, Inc. CRAY $21.61 5 8.0 0.67 $875
Kulicke & Soffa KLIC $10.83 5 1.6 0.85 $826



NOTE: SE/TA (Shareholder Equity-to-Total Asset Ratio: Ratio used to determine the value that shareholders would receive if the event the company liquidated. To be considered financially sound, a company should own at least twice what it owes for a ratio of .50 or greater.




[1] Amey Stone, “Homespun Wisdom from the ‘Oracle of Omaha’,” BusinessWeek 25 Jun 1999, Print.

About the author:

Charles Mizrahi
Charles Mizrahi is editor and publisher of Hidden Values Alert newsletter, which focuses on finding stocks trading significantly lower than their underlying business value. He has over 30 years experience in the financial world as a money manager and investor.

Visit Charles Mizrahi's Website


Rating: 4.4/5 (10 votes)

Comments

Cornelius Chan
Cornelius Chan - 1 year ago
"His results, when he managed small sums in his Buffett Partnership (BP), were truly amazing. From 1957 through 1968 the Dow Jones annual compounded rate was 9.1%, compared to BP’s limited partner’s return of 25.3%. Over a 10-year span, Buffett, working with relatively small sums of money, was able to almost triple the Dow Jones return … and he never had a losing year."

Buffett claims he could make 50% with small sums. When he did manage small sums back in he 50's and 60's, he only made 25.3%? I don't get it. Of course, he is probably speaking of "if I knew then what I know now..." type of approach.

From what I understand, the market today is less filled with Graham-type bargains and net-nets. So where is Buffett getting his 50% compound annual returns?

Keep looking my friends.

BEL-AIR
BEL-AIR - 1 year ago
I was just about to type what C.W.R said but he beat me to it...

The type of deals Buffett used to get when he made his 25.3% returns a year are not even around anymore.... He was buying net nets and companies for cash on the books or less.

I been studying Buffett and Graham since the 1990's including what they bought and at what valuations going back to the late 1940's of their careers, trying to find any nugget I could as to what companies and valuations they were buying at, and those types of valuations do not exist any more...

For example Buffet bought one company for less than half of the price of one years earnings once, Graham bought a railway stock for less than half the value of the bonds it had on the books and got the rest of the company for free.

Why do you think Graham retired back in 1953? There weren't hundreds of the net nets or other bargains he used to hold and he pretty much even admitted it himself.

I been reading alot on Walther Schloss lately and he was able to find the odd net nets or pay a little higher for type of stocks and others until about the 70's until that pretty much dried up to. Then he just bought cheap low price to book ratio's as long as they had low to no debt and bought up to a hundred at a time to protect himself against such cheap but low quality issues...

But even this stratagey of buying half book stocks with no debt and some earnings had gotten so hard and rare to buy in large baskets that Schloss and son retired in 2001, and they stated that this was the reason along with Walters age at the time. Schloss during interviews stated that there is simply to many value investors around nowadays and all the bargains have dried up, he actually blamed Buffettt's popularity to attracting so many Value investors into the game that all the deals were now gone

Fact is there was no competition or many value investors back in 1940's etc, no stock screeners were you could type in a few things and there you have it. Sure fund managers today can't invest their client portfolio's in small stocks under 2 billion, but they sure would their own money, or that or their wife's or childs educational fund.

Everything today is more competitive today as opposed to the 1950's from body building, sports, singers to investing.... Everybody is better trained.......

Just the way it is.... You are just fooling yourself to think otherwise.

batbeer2
Batbeer2 premium member - 1 year ago
>> The type of deals Buffett used to get when he made his 25.3% returns a year are not even around anymore.... He was buying net nets and companies for cash on the books or less.

They are around today.

Less than three weeks ago, a stock trading at net cash was discussed on this forum.


P.S.

Until recently, Buffett was earning 100k per annum. That was his income.

If the man says "In fact I know I could make 50%" he probably really does know. One way he could know this is through the performance of his personal portfolio which is likely in the millions; based on his income.
sdnarra
Sdnarra - 1 year ago
Estimates of Buffetts personal portfolio range as high as 800 million. Based on his prowess in the past, i don't doubt it. Because we haven't figured out how does not mean he can't.

Noone has figured out a way to run 100m under 9.6s but Usain Bolt has. It does happen sometimes.

I think the past 15 yrs especially have been hard on value investors, but if you were sitting on any cash at all in 2008/9 and did not act, then you've got only yourself to blame.

That said, even Charlie Munger admitted he was scared senseless to buy then. So it must have been a unique situation.

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