I often like to look at long-term past performance of investors (10 years or longer) to draw conclusions about the effectiveness of their investment approach. I've often discussed on this site the many value investors out there with average returns.
I used to ask myself, "How can their returns be average when they clearly are smart people who understand business and value investing principles?"
In most cases, I've concluded that their average results are not because they don't understand effective investment principles, but it's because they are not willing to implement an investment policy that goes against the consensus opinion of the majority.
I've mentioned before that one of the things that can benefit an investor who is looking for above-average long-term results is to study a select few investors who have made 20% to 30% annual returns over long periods of time. They will most likely be value investors, and they all mostly share the same principles. But if you really dig into how they managed their portfolios, you'll notice two key differences in most cases:
- They were either very diversified but owned a lot of Graham-type stocks at very low prices relative to earnings/assets, or...
- They were very concentrated and owned just a few select outstanding businesses.
- Lampert made 30% for the better part of two decades but usually had fewer than 10 stocks.
- Pabrai has averaged 25% for almost 20 years now, but typically owns 10 stocks or less, etc.
- Graham made 20% per year from 1936 to 1956 by owning a diversified basket of value stocks.
- Schloss had one of the "longest-best" track record I know of: 21% for nearly 50 years! He typically owned many stocks and they were all cheap, unloved Graham stocks.
Combining Strategies Dilutes PerformanceMy conclusion after studying countless other investors' portfolio holdings and their results is that most investors (even most value fund managers) will end up combining aspects of No. 1 with aspects of No. 2.
In other words, they end up using diversification (like Graham and Schloss) and combining it with owning great businesses (like Munger and Buffett). This leaves them with too many stocks at mediocre prices. It's just the way the market works.... great businesses rarely go on sale. Occasionally they do, but not often enough to own 30 or 40 of them at once. This type of portfolio management will just will lead to overpaying for good merchandise, and thus lowering your overall portfolio returns.
If you want to diversify, you have to own the cheapest stocks in the market, and those typically aren't easy to own. If you want the best businesses, you have to really focus on the best businesses (for an extreme example of the latter, check out Allan Mecham's latest 13-F). Both can work, but too many investors end up sacrificing valuation in the name of quality.
So it's important to "Think Differently." Invert, always invert.
Buffett vs Munger vs Schloss RecordI thought it would be fun to display the results of three of the greatest of all time. Munger was a franchise, high-ROC type investor. Schloss was exactly the opposite. He owned cheap stocks. Buffett had elements of both, and it was around this time that he was transitioning from the latter to the former.
Here are the three head to head during the time they were all running outside capital (Buffett's results are his partnership results until 1969, and the book value growth of Berkshire thereafter). This is like Ruth vs Aaron vs Williams.
Note: These are gross returns before fees. I wanted to display the effectiveness of the strategy before accounting for various fee structures that the three investors had. But both gross and net returns vastly outperformed the market.
So Buffett won this three way battle from 1962 through 1975. Munger retired his partnership after 1975. And despite Walter Schloss coming in third place during the above period (although still crushing the Dow), it's worth noting that Schloss went on the best streak of his career from 1975 to 1983, averaging in excess of 30% per year during that time period.
Suffice it to say that each investor had his own style, but they had one thing in common: They all did things far differently than the crowd, and thus achieved results that were far different than the crowd.