Coffee Cans vs. Punch Cards: The Balancing Act of Portfolio Management

During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, and Huber discussed Coffee Cans vs. Punch Cards: The Balancing Act of Portfolio Management. Here’s an excerpt from the episode:

Tobias: What’s your longest-term investment, John? Have you held onto anything for the whole ride?

John: I don’t have anything from 10 years ago. The longest investment is seven years. Yeah, ideally, I have a few that I look out 10 years and say, “Hey, I hope I continue to own this in 10 years.” But the reality is, back to those Buffett partnership letters, one of the things he says in there is, I do think there’s a balance between the never sell mentality and the reality that you have a certain amount of equity in each investment, and your goal, as an investor, is to compound that equity at the highest rate you can with a minimum of risk on an after-tax basis.

And so, your goal is not to achieve a 30-year investment that’s in the coffee can and your cost basis is a dollar and the stocks worth $300. That’s always a nice story and stuff. Obviously, that would be ideal if you could do that.

Jake: Yeah, let’s just do that if it’s so easy.

[laughter]

John: I have mixed feelings on that, because I have these dissonance in my head between the coffee can mentality where you have a certain amount of investments and you let them go. The ones that work are going to grow into these fabulous winners, and the ones that don’t become more or less irrelevant, and then you couple that with the punch card mentality. And the punch card mentality means focusing on your best ideas. You’re always going to have– We were talking about Apple. Apple at 10 PE is a lot different than Apple at 30 PE. If you bought it at $10 and you still own it at $30, it might turn out to be– that’s the right thing to do, and that’s great. But your equity at $30 might compound at a lower rate than–

Jake: Something else.

John: Something else in your portfolio. So, to me, a tricky thing. That’s what makes investing so fun and so interesting is there’s no way to truly master it, because you never know in real time what those opportunity costs are. Specifically, you have an idea of what they might be, and your job is to try to optimize those. Yeah.

Jake: That assumes that you have to be right about the business also over very long periods of time. That’s no easy. Buffett and Munger have talked about how– They found a handful of those things where they felt super confident that that business was going to be bigger in 20 years, bigger and better. That’s at looking at, I don’t know, what, probably 10,000? It’s an incredibly small number of actual that surfaced as being these obvious inevitables as he called it at one point.

Tobias: Well, the two inevitables were Coke and Gillette, weren’t they?

Jake: Original? Yeah. Those were–

Tobias: Do you think they look as inevitable now as they did then?

Jake: Hard to say. Gillette’s inside a PNP now, right?

John: They certainly have been incredible companies, but things do change. Yeah, you look at Coke and you say, “Ah, I don’t know.” if the sugar consumption in developed worlds is probably growing at a slower rate or even at a stagnant rate, Coke servings might be– You could see a scenario where maybe it doesn’t look as bright in the future. But it’s less about is Coke right or Gillette right or wrong? To me, it’s like things change over time. So, you have to be adaptable somewhat. And again, if you think about the partnership letters, he bought Disney and sold it. And that probably was a mistake. He calls it a mistake. I think it’s actually debatable whether that was a mistake, because if you look at how his equity compounded.

Jake: Yeah, what he put it into?

John: Yeah, what he put it into worked out pretty well. But American Express is another one that held for four years, and it quadrupled. It went up 4x, and it got to a level where presumably– he doesn’t talk about in his letters, but presumably he felt like it was probably fairly valued, and so he sold it to buy something else. I think that’s more along the lines of how, I would say, most of us operate unless you own a holding company where you have excess cash coming in, or perhaps, you’re an individual investor, and you have excess cash from your employment, and you can operate your own little mini-Berkshire Hathaway doing that. Never sell anything, and just keep putting money into your next best idea. That’s actually not a bad strategy as an individual. But I think Buffett would be running money differently if he were running a smaller amount inside of a fund. He would be– [crosstalk]

Jake: At a fixed pool of capital.

John: Yeah. You wouldn’t hold Coke at 50 times earnings. I think even he admitted that might be extreme. So, some of these investments get to extreme levels where I think you may want to reevaluate your cost of equity capital. Meaning, your opportunity costs in your portfolio and reallocate to something that has better. I have a low turnover approach, and I love the idea of owning something forever. But the reality is stock prices adjust and opportunity sets are always changing, and so you have to couple those two different viewpoints, I guess.

Jake: I think maybe Munger’s got it right when it’s like marriage where you want to go into the investment with your eyes wide open, but once you’re there, maybe it pays to have them a little bit shut.

Tobias: [laughs]

John: Yeah. [laughs] You want to give things time too. The other side of the coin is businesses go through rough patches. And so, as an investor, obviously, you want to be cognizant of that and be ready to add perhaps, and not be too quick to adjust. And then on the other side of the coin, when things work out well, like Microsoft, and all of a sudden, they have this incredible cloud machine, and the stock went from $10 to $15, well, don’t be too quick to sell, because it’s still a great business. It’s still a 6% yield. It’s got all this growth in front of it. Maybe that’s still worth holding. So, you have to hold those two opposing views. When I say opposing views, coffee cans/punch card, you have to hold those two simultaneously, and that’s part of the trick of portfolio management, I think.

Tobias: Buffett did slightly do something with that Coke holding when he merged into Gen Re. He used the overvalued Berkshire traded into undervalued Gen Re, get the dilution that way. So, it’s didn’t really sell it down, but got the tax free dilution of the position at least with a big slug of bonds.

Jake: Right. He turned claim checks on overvalued Coke into bonds, basically, in a tax– [crosstalk]

John: That’s a really interesting way to look at it. Yeah, he issued stock, which he’s loathe to do. He did it because presumably he felt like that arbitrage made sense given the contents of his portfolio and the valuations of the stocks he held. So, that’s a good way to look at it.

Jake: And it was 3 times book on 60 times PE Coke look through. That’s a pretty watered down analogy or something.

John: Yeah. So, you could look at that and say, he did that or maybe it would have made more sense just to sell the position. But Berkshire is in such a great spot where you don’t need to sell anything because you have this cash coming in monthly. And so, you got this huge tax deferred liability and you got all this cash coming in, so it’s a different situation. It’s a pleasant place to be in.

Jake: Sounds like a fun game.

John: Yeah.

[laughter]

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