Concentrate And Let Your Winners Run | The Acquirer's Multiple®

During his recent interview with Tobias, John Huber, Managing Partner at Saber Capital Management discussed the importance of running a concentrated portfolio, and letting your winners run. Here’s an excerpt from the interview:

Tobias Carlisle:
And when you find them, how much are you looking to allocate to any given company as a proportion of the portfolio?

John Huber:
Yeah, that’s an interesting question because I think portfolio management is a big part of the equation. So I’ve always thought that the simple concept of value investing is easy for everyone to understand and it’s very difficult to implement. And again, for my type of investing, I think there’s just not that many great ideas. And so, I think a lot of investors have two or three or four really good ideas and then they water those two or three or four ideas down with 15 to 20 other ideas. And that tends to dilute the value of those few great ideas.

John Huber:
And so, I try to, as best as I can, eliminate the ideas that dilute those few ideas. And so, it’s a long way of saying it’s a concentrated portfolio. In the ideal world, I’d have 20 stocks and they’d all have an equal roughly approximately equal risk reward. But in the real world, it doesn’t usually work that way. And so, it tends to be a very concentrated approach. And there’s more than two or three or four that I typically have between five and 10 stocks in the portfolio at any given time. So it’s quite concentrated, but it depends on the situation.

John Huber:
So sometimes a starter position might be 5%, sometimes it might be 10%. And then on the rare occasions where there’s high conviction, it can be upwards of 20% of the portfolio. And the biggest positions in my portfolio tend to be the ones where I’m most convinced or most convicted in the risk reward. And I guess more importantly, the biggest ideas tend not to be the ones where I think might have the most upside but have the least downside. So that’s kind of how I think about position sizing. You know, the… Go ahead.

Tobias Carlisle:
Sorry, go ahead.

John Huber:
I was just going to say the wider range of outcome… Stocks have a certain range of outcomes. I think about it like a barbell. So on the left, if you picture a barbell, on the left side of the barbell, you have what I consider to be like the real defensive names, the really durable names. So the Berkshires of the world. The range of outcomes is quite small for some of those types of companies. They’re very defensive, they’re very… Berkshire is somewhat economically sensitive, but it’s a very stable business with a strong balance sheet. So other companies in that list might be like waste management or something like if you’re a trash collector. Your revenues are fairly predictable in any given year and therefore the outcomes are fairly narrow.

John Huber:
So I don’t tend to invest a lot in those, but as you move your way down the spectrum from the left side of the barbell to the right side, at the other end of the spectrum we have more of the cyclical companies that have a wide range of outcomes. So like an oil refinery, for example, it doesn’t control the cost of its input, it doesn’t control the cost of the product it sells, and therefore the margins can be all over the place. It’s a very volatile business and therefore the stock price is very volatile.

John Huber:
So I don’t really invest at that end either, it’s sort of the opposite of I think to Taleb’s approach where he says, “Invest at both.” And I’m kind of more in the middle where I think of two categories in the middle of that barbell, which are more of the secular growth businesses that have a durability to their business and are very likely going to be doing better in say five to seven years than they are now. And then maybe more of the fast growers. So there’s like the durable growers and the fast growers which have more of a wider range of outcomes and are more economically sensitive, but have more upside potential possibly.

John Huber:
So those are sort of where I like to look for investments, but the bigger positions tend to be on the left side of the barbell and the smaller positions tend to be on the right side of the barbell because of the distribution of possible outcomes.

Tobias Carlisle:
The narrower the distribution of possible outcomes, the larger the position tends to be. And the wider the distribution of outcomes, the smaller the position tends to be.

John Huber:
That’s how I think about it. Yeah. Yeah, I really think about it in terms of downside. So in theory, you could have something with a wide possibility of outcomes at a certain valuation where the range of outcomes exist more on the upside and that could be potentially a bigger position. So it just obviously depends on price, but that’s generally how I think about it.

Tobias Carlisle:
If you sold something to 20% at inception and everything goes right and the position gets very big, do you trim them back to… How are you thinking about it on a sort of continuous basis? Are you trying to trim them back to their appropriate risk weighting in the portfolio? And then is that a valuation question or is that some other consideration?

John Huber:
Yeah, that’s what I really struggle with, Toby, it’s selling has always been a difficult proposition because if you invest in an operating business, in an ideal world, someone was talking about this the other day, like the coffee can portfolio where, I don’t know if you’re familiar with that concept, but basically if you’re an individual investor, it’s really a great way to invest. You pick one stock a year or one stock every so often and you put your savings into it after you’ve spent a careful amount of time researching it, and you put it in the coffee can, so to speak, and you forget about it. And then every year you add to it. And I think individual investors probably improve their results if they thought that way.

John Huber:
And I think as professionals, and again, at least for my type of a longer term low turnover approach, that approach works. So the problem is, is when the stock appreciates, if you have a 20% position, and this is a First World problem to have, but if the position goes in your favor and it becomes a 30% position, what do you do with it? For me, I tend not to trim those positions unless the valuation gets to a level where I consider it to be significantly stretched or my future returns are going to be worse than cash, for example.

John Huber:
I always tend… I’ve learned from this because the best investments I have made, I’ve tended to trim things too early and that has reduced unfortunately the returns that I could have achieved. And in hindsight, when you think a stock reaches its fair value, I’ve often found that in hindsight it still was undervalued. So I tend to think about it in terms of opportunity costs. So if the position gets to a market, what I consider to be a market return going forward or sort of an opportunity cost, let’s say the S&P is your opportunity costs and let’s say that’s 7%, just to put a number on it.

John Huber:
If a stock gets to a level where your future returns are going to sort of match the market, I’ll tend to hold those until they get to a level where I think I might actually lose money at this level. So if the stock it’s overvalued. Because again, I’ve learned that the best businesses tend to often look overvalued and they still are oftentimes fairly valued or in some cases they’re still undervalued. So unless something gets egregiously overpriced, I’ve tried to do my best to not trim things.

Coffee Can Investing

Tobias Carlisle:
Yeah. There’s a great story about Claude Shannon who was the father of information theory and he worked at Bell Labs, had an association I think with MIT. And so, he got to invest in a lot of companies very early on, Motorola and so on, was one of them. And he’d put the money in and then never touched it. And so, by the time that he passed away, I think it was Motorola, was like 88% of his portfolio because it had gone so well, but everything else in his portfolio had performed as well. It was just that Motorola had been such a spectacular return. I forget the numbers, but they’re just silly numbers, like a hundred thousand percent or something like that.

John Huber:
Yeah. Right. Yeah. And so, at that level, that’s an extreme example. And again, it’s in the coffee can, the reason you put the stock certificate in the coffee can is you just forget about it. You lock it away. Put it in a vault somewhere and just don’t think about it. And that’s sort of what he did with Motorola.

John Huber:
And there are fund managers that have implemented approaches that resemble that coffee can idea which I really love. But it’s very difficult as a money manager to do that, I think. I don’t know what your thoughts are on that, Toby, but it’s hard. Because if a stock gets to 88% of your portfolio [crosstalk 00:39:44]-

Tobias Carlisle:
Your fortunes are tied to that stock.

You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:

Apple Podcasts