QUALIPORT
Big Bold Bets are Best

By Maynard Paton (TMFMayn)
January 18, 2001

Rochester, Kent – If you invest in individual shares, then making big and bold investments is the only way to consistently beat the stock market over the long-term.

The point was highlighted in the latest Duelling Fools feature, a duel that debated the subject: "Can Fools Beat the Market?"

TMFNigel, presenting the "Yes, they can!" argument, ventured the following:

"It's hard to find good companies trading at a bargain price, or great companies trading at a reasonable price. So when you find an attractive situation where you are highly confident of a favourable outcome, you should invest a meaningful amount. If you are confident of your investments then why hold any more than 10 individual investments at any one time? If you are REALLY confident then why hold any more than 5 investments?"

The evidence that a focused approach is required for a market-beating portfolio is compelling. Take three market-beating investors known to most Fools – Warren Buffett, David Gardner and TMFPyad. Each of them has different investment styles, yet all three run very tight portfolios.

Buffett's Big Bets

Taken from his Shareholders' Letters, this is Buffett's record of common stock holdings as at the end of each year since 1977.

Year       Number of       Portfolio Percentage
         Companies Held     of Largest Holding 

1977           9                 18.4
1978           8                 19.7
1979          13                 20.3

1980          18                 19.9
1981          15                 31.3
1982          11                 32.7
1983          10                 31.1
1984          10                 31.3
1985           7                 49.7
1986           5                 42.8
1987           3                 48.9
1988           5                 35.6
1989           5                 34.8

1990           6                 40.2
1991           8                 41.5
1992           9                 34.2
1993           9                 37.0
1994          10                 36.9
1995           7                 33.7
1996           9                 37.9
1997           8                 36.8
1998           7                 36.0
1999           6                 31.5

2000          TBA                TBA

Before going any further, there are two points to note from the above table:

• Buffett's common stock portfolio has become much smaller in relation to his other "whole company" investments in recent years, and;
• Buffett only declares shareholdings over a certain value, and the table reflects just the number of companies so reported. However, in most years, "other investments" were insignificant compared to the overall portfolio size.

But even with those two caveats, the picture is clear:

• Buffett usually has less than ten common stock holdings of any notable size, and;
• Buffett usually has a third of his common stock portfolio invested in one company.

Including his other investments, Buffett has compounded the asset value of Berkshire Hathaway (NYSE: BRK.A) at an average of around 20% since the mid-1960s.

Lessons from America

On to David Gardner, owner of the US Fool's Rule Breaker Portfolio. Here's a similar table, taking the Rule Breaker's position as at the end of each year.

Year       Number of       Portfolio Percentage
         Companies Held     of Largest Holding

1995           8                 27.1
1996          10                 26.2
1997          13*                19.1
1998          13*                28.2
1999          11                 37.5
2000           7                 36.3

(* includes one "short")

A point to note here is that the Rule Breaker had incorporated the "Foolish Four" mechanical strategy until 2000. Before their ejection, the Foolish Four were largely irrelevant to the overall size of the portfolio. So, in a sense, the Rule Breaker has also achieved its success from running a sub-10 stock portfolio. Notice too how the Rule Breaker has averaged a 30% weighting in just one stock.

The latest figures show that the Rule Breaker has compounded its growth at around 40% per annum since inception.

Bet the farm

And finally, TMFPyad. Now, TMFPyad doesn't run a "public" portfolio in the same way as Buffett or Gardner, but another table can be deduced from his Value reviews of 1999 and 2000. Ignoring a "side bet", this is the ultimate in concentrated portfolio operation.

Year       Number of       Portfolio Percentage
         Companies Held     of Largest Holding

1999           1                100.0
2000           1                100.0

According to TMFPyad, his own portfolio generated a 452% return in the seventeen months from September 1998.

Qualiport

So, how does the Qualiport shape up on a similar year-end analysis?

Year       Number of       Portfolio Percentage
         Companies Held     of Largest Holding
 
1998           6                 21.0
1999           8                 23.0
2000           6                 26.8

Although the Qualiport has had a reasonably focused portfolio over its short life, it hasn't managed to succeed in its market-beating quest.

Entering 2000, the Qualiport's largest holding was an (in hindsight!) over-rated Misys (LSE: MSY) (the subsequent share price performance of which can be seen here) and the start of 1999 saw the Qualiport weighted towards a soon-to-go-ex-growth Rentokil Initial (LSE: RTO) (the share price performance of which can be seen here).

Nevertheless, we're still running a concentrated portfolio. Here's how the Qualiport stands now.

Holding                  Portfolio Percentage
 
PizzaExpress                    28.4
MMT Computing                   25.7
Independent Insurance           18.9
Lloyds TSB                      12.0
Emap                            10.3
Dell Computer                    4.7

If anything, the portfolio continues to increase its focus.

But only time will tell whether our stock picking has improved. It stands to reason that the more concentrated a portfolio you have, the greater the chance of diverging from the stock market mean. But of course, the real investment trick is to ensure that your concentrated portfolio consists of shares that will subsequently diverge in the correct direction!

Your turn

Just for fun, here are two polls to discover whether Qualiport readers run focused portfolios.

Q1. How many different companies currently make up your share portfolio?

* 5 or under
* Between 6 and 10
* Between 11 and 15
* Between 16 and 25
* Over 25

Click here to vote.

Q2. What percentage of your portfolio's value does your largest individual holding currently represent?

* Under 10%
* Between 10% and 20%
* Between 20% and 30%
* Between 30% and 50%
* Over 50%

Click here to vote.

Your thoughts on the benefits or dangers of running a focused portfolio can be directed to the Qualiport message board.