VRX - Valeant Pharmaceuticals International Inc.

[rishig]

It's difficult to avoid mistakes, but it's worse when your portfolio is so heavily skewed towards 1-2 stocks that you may have winners in the rest of your portfolio, it wouldn't matter. Picking 3 stocks for your portfolio is not for mere mortals like us. Best to leave that kind of concentration to Munger.

 

I think running a concentrated portfolio of equal sized positions with contrarian bets is best suited for individual investors that are enterprising (Ben Graham's definition) or for managers with permanent capital.

 

One comment I'd make on this is that it heavily, heavily depends on what you own. I never hear about this. If your three stocks are Mastercard, Union Pacific, and Berkshire, are you at risk for some horrible worldly outcome?

 

On the other hand, if your three stocks are Twitter, Tesla, and Herbalife, I'm not sure the concentrated life is for you.

 

In my opinion, there's a lot more to it than "How many stocks?" Well...which ones? Valeant was a poor choice for a 1/3 weighting because it was enormously leveraged, used very aggressive accounting, and had an increasingly aggressive business model to back it up, led by some extremely aggressive incentive plans. The risk inherent in Berkshire or CSX or Procter & Gamble is so far less...

 

I think where the concentration idea gets into trouble is when the P&G's of the world are not offering you the returns you desire. That's my theory of what happened with Sequoia. They didn't think they could get the returns they were used to in low-risk business models, so they were seduced into sizing up a very aggressive one. If they had simply bought more TJX or Mastercard, or O'Reilly, or any number of lower-risk businesses in their portfolio, we'd never have had this discussion. It's really fascinating.

 

May be it's just hard to say what is "lower-risk" in foresight. Better to just use prudence and not get overly concentrated. I have heard Pabrai / Spier say that they would not buy bigger than 10% position but would let the stock run up and be 30%-40% of the portfolio. I think the danger with such a portfolio philosophy is the same. It works 9 out of 10 times, but the one time it blows up, it destroys 10 years of compounding.

 

I'm sorry but I do not agree -- the foresight thing is a cop-out. Does it take a genius to know that Valeant with $30 billion of debt, trading at an astronomical price compared to any non-gameable metric, is way higher risk than Berkshire Hathaway? By an order of magnitude? I had a conversation with some board member on this a few years ago when it was riding high and he couldn't see it. (I don't know if he held on, but I hope not.) Is it possible to know that Wal-Mart in 1997 and Pier One Imports in 1997 had very different risk levels even if their 10-yr figures probably looked the same?

 

If you can't make these differentiations, I don't know what to tell you...this might not be the right line of work. Buffett called it the "Hula-hoop company vs Barbie company" problem -- the numbers would look similar or even better for the HH company while it was hot, but a good analyst knows the difference. That's the essence of the process.

 

I respect Sequoia, Guy S., and Mohnish greatly, I do. But I simply do not think the stuff they loaded up on -- ZINC, FIAT, GM, VRX, and so on -- are the types of companies Buffett and Munger invest heavily in, or the things they have in mind as concentrated investment candidates. That's why Munger was so vocal about VRX, why he was so wishy-washy about Ted W. owning GM in size, and why Buffett made it clear he was quite surprised to see one of his guys investing in Kinder Morgan. (See CNBC transcript online.)

 

Concentration and conservative investments go hand in hand - you can't have one without the other. And if you can't tell, a priori, what a low-risk business looks like, I'm not sure you have any business actively managing money.

 

To be clear, if you're more comfortable with 20 stocks instead of 3, that's completely fine - I take no issue with it. That's worked well for some. But going from 20 to 3 is perfectly possible if you're smart about how you do it. I'm amazed at how everyone handwaves away one of the biggest parts of the Buffett/Munger philosophy.

 

Just to be clear, I have been one of the guys on this thread saying Valeant didn't make sense. So, I am not trying to say Valeant could not have been identified as a mistake in foresight. (Take it easy with your tone, please).

 

What I am saying is that it is not *always* possible to identify every risk or mistake in foresight (do you want me list every mistake that Buffett and Munger have made?). In fact, investing is a probabilistic thing and not every thing can be seen in advance. Also, there is a fine line between confidence and arrogance. Just my personal opinion, once something is in the 30% range, I feel I am bordering on the line of arrogance. Do I really don't have 5 other stocks I can own? And how am I so confident that I am willing to bet my 10 years of compounding on this thing (whatever that thing turns out out to be - MA, P&G, WFC, AXP).

 

I know that biggest parts of Buffett philosophy is to make huge big bets on a few ideas. That's great. I am not a Buffett or Munger. I am the above average poker player who does not want to lose my bankroll and live a long life. As long as I don't get pushed out of the game, compounding will take care of the rest. I don't aspire to be the next Buffett (because I know I am not that smart).

 

Also, I am not managing anyone's money, so my business is my business. I am free to choose the philosophy that works best to manage my hard earned dollars (and have been doing long enough to stay humble).

[Eye4Valu]

Someone remind me where Lou Simpson managed money all those years. He surely wouldn't invest in something like Valeant, now would he?

[coc]

Just to be clear, I have been one of the guys on this thread saying Valeant didn't make sense. So, I am not trying to say Valeant could not have been identified as a mistake in foresight. What I am saying is that it is not *always* possible to identify every risk or mistake in foresight. In fact, investing is a probabilistic thing and not every thing can be seen in advance. Also, there is a fine line between confidence and arrogance. Just my personal opinion, once something is in the 30% range, I feel I am bordering on the line of arrogance. Do I really don't have 5 other stocks I can own? And how am I so confident that I am willing to bet my 10 years of compounding on this thing (whatever that thing turns out out to be - MA, P&G, WFC, AXP).

 

I know that biggest parts of Buffett philosophy is to make huge big bets on a few ideas. That's great. I am not a Buffett or Munger. I am the above average poker player who does not want to lose my bankroll and live a long life. As long as I don't get pushed out of the game, compounding will take care of the rest. I don't aspire to be the next Buffett (because I know I am not that smart).

 

Fair enough -- do what works for you. I'm sure you'll do very well - and I saw you warning against VRX so I'm not trying to argue otherwise.

 

My point is, don't think that concentrated investing has to be left to the geniuses. You said "leave it to Munger" and I do not agree. You just have to avoid getting dollar signs in your eyes when an attractive but risky situation comes along. Buffett/Munger have been remarkably disciplined. Remarkably. So I would, perhaps, agree with you in that sense. Maybe not everyone can resist the Siren call.

[rishig]

Just to be clear, I have been one of the guys on this thread saying Valeant didn't make sense. So, I am not trying to say Valeant could not have been identified as a mistake in foresight. What I am saying is that it is not *always* possible to identify every risk or mistake in foresight. In fact, investing is a probabilistic thing and not every thing can be seen in advance. Also, there is a fine line between confidence and arrogance. Just my personal opinion, once something is in the 30% range, I feel I am bordering on the line of arrogance. Do I really don't have 5 other stocks I can own? And how am I so confident that I am willing to bet my 10 years of compounding on this thing (whatever that thing turns out out to be - MA, P&G, WFC, AXP).

 

I know that biggest parts of Buffett philosophy is to make huge big bets on a few ideas. That's great. I am not a Buffett or Munger. I am the above average poker player who does not want to lose my bankroll and live a long life. As long as I don't get pushed out of the game, compounding will take care of the rest. I don't aspire to be the next Buffett (because I know I am not that smart).

 

Fair enough -- do what works for you. I'm sure you'll do very well - and I saw you warning against VRX so I'm not trying to argue otherwise.

 

My point is, don't think that concentrated investing has to be left to the geniuses. You said "leave it to Munger" and I do not agree. You just have to avoid getting dollar signs in your eyes when an attractive but risky situation comes along. Buffett/Munger have been remarkably disciplined. Remarkably. So I would, perhaps, agree with you in that sense. Maybe not everyone can resist the Siren call.

 

Did you see Eye4Valu's comment. Buffett devoted a section in 2004 letter titled "Portrait of a Disciplined Investor", saying Lou's picks had produced an average return of 20% compounded since 1980. Did he also have dollar signs in his eyes? I am leaving super concentrated investing to the geniuses. No, thank you. 15-20 stocks are concentrated enough for me to get alpha without blowing up completely on a single error.

[writser]

I know that biggest parts of Buffett philosophy is to make huge big bets on a few ideas. That's great. I am not a Buffett or Munger. I am the above average poker player who does not want to lose my bankroll and live a long life. As long as I don't get pushed out of the game, compounding will take care of the rest. I don't aspire to be the next Buffett (because I know I am not that smart).

 

Couldn't agree more. Slow and steady is the way to go for 99.99% of all investors. By owning a three stock portfolio you are basically saying that you make no mistakes. That's not something I would like to bet my retirement money on - I'd prefer not to go broke if I am not as smart as I think I am. Also, you should consider the utility of all possible outcomes. Suppose you can choose between the following (simplistic) scenarios:

 

3 stock portfolio:

90% chance of 20% return p.a..

10% chance of going broke.

 

20 stock portfolio:

90% chance of 10% return p.a.

10% chance of 2% return p.a.

 

Obviously, on average the first strategy is way better. However, depending on your age, job and portfolio size you should be extremely worried about going broke. The second strategy might be your best pick unless you are 18 (or you know for sure you are a genius).

 

You could argue that you can buy 3 Berkshire-like companies and that your 'look-through' portfolio is reasonably diversified. In that case I might agree but such a portfolio wouldn't outperform the market by a huge stretch anyway.

[rishig]

I know that biggest parts of Buffett philosophy is to make huge big bets on a few ideas. That's great. I am not a Buffett or Munger. I am the above average poker player who does not want to lose my bankroll and live a long life. As long as I don't get pushed out of the game, compounding will take care of the rest. I don't aspire to be the next Buffett (because I know I am not that smart).

 

Couldn't agree more. Slow and steady is the way to go for 99.99% of all investors. By owning a three stock portfolio you are basically saying that you make no mistakes. That's not something I would like to bet my retirement money on - I'd prefer not to go broke if I am not as smart as I think I am. Also, you should consider the utility of all possible outcomes. Suppose you can choose between the following (simplistic) scenarios:

 

3 stock portfolio:

90% chance of 20% return p.a..

10% chance of going broke.

 

20 stock portfolio:

90% chance of 10% return p.a.

10% chance of 2% return p.a.

 

Obviously, on average the first strategy is way better. However, depending on your age, job and portfolio size you should be extremely worried about going broke. The second strategy might be your best pick unless you are 18 (or you know for sure you are a genius).

 

You could argue that you can buy 3 Berkshire-like companies and that your 'look-through' portfolio is reasonably diversified. In that case I might agree but such a portfolio wouldn't outperform the market by a huge stretch anyway.

 

One of my favorite investment lesson is from the chapter "Defining your Investment Goals" from Seth Klarman's book "Margin of Safety".

 

"Table [below] shows the delightful effects of compounding even relatively small amounts.

 

Compound Value of $1,000 Invested at Different Rates of Return and for Varying Durations:

Rate	5 Years	10 Years	20 Years	30 Years
6%	1,338	1,791	3,207	5,743
8%	1,469	2,159	4,661	10,063
10%	1,611	2,594	6,727	17,449
12%	1,762	3,106	9,646	29,960
16%	2,100	4,411	19,461	85,850
20%	2,488	6,192	38,338	237,376

 

As the table illustrates, perseverance at even relatively modest rates of return is of the utmost importance in compounding your net worth. A corollary to the importance of compounding is that it is very difficult to recover from even one large loss (emphasis mine), which could literally destroy all at once the beneficial effects of many years of investment success. In other words, an investor is more likely to do well by achieving consistently good returns with limited downside risk than by achieving volatile and sometimes even spectacular gains but with considerable risk of principaL An investor who earns 16 percent annual returns over a decade, for example, will, perhaps surprisingly, end up with more money than an investor who earns 20 percent a year for nine years and then loses 15 percent the tenth year. There is an understandable, albeit uneconomic, appeal to the latter pattern of returns, however. The second investor will out-perform the former nine years out of ten, gaining considerable psychic income from this apparently superior performance. If both investors are money management professionals, the latter may also have a happier clientele (90 percent of the time, they will be doing better) and thus a more successful company. This may help to explain why risk avoidance is not the primary focus of most institutional investors."

 

Concentrating one's portfolio in 3 stocks may produce high alpha, but what if that is not my goal. May be my goal is just loss-avoidance and to compound at a reasonable rate.

[shalab]

+1 on Klarman book note and this message.

 

 

One of my favorite investment lesson is from the chapter "Defining your Investment Goals" from Seth Klarman's book "Margin of Safety".

 

"Table [below] shows the delightful effects of compounding even relatively small amounts.

 

Compound Value of $1,000 Invested at Different Rates of Return and for Varying Durations:

Rate	5 Years	10 Years	20 Years	30 Years
6%	1,338	1,791	3,207	5,743
8%	1,469	2,159	4,661	10,063
10%	1,611	2,594	6,727	17,449
12%	1,762	3,106	9,646	29,960
16%	2,100	4,411	19,461	85,850
20%	2,488	6,192	38,338	237,376

 

As the table illustrates, perseverance at even relatively modest rates of return is of the utmost importance in compounding your net worth. A corollary to the importance of compounding is that it is very difficult to recover from even one large loss (emphasis mine), which could literally destroy all at once the beneficial effects of many years of investment success. In other words, an investor is more likely to do well by achieving consistently good returns with limited downside risk than by achieving volatile and sometimes even spectacular gains but with considerable risk of principaL An investor who earns 16 percent annual returns over a decade, for example, will, perhaps surprisingly, end up with more money than an investor who earns 20 percent a year for nine years and then loses 15 percent the tenth year. There is an understandable, albeit uneconomic, appeal to the latter pattern of returns, however. The second investor will out-perform the former nine years out of ten, gaining considerable psychic income from this apparently superior performance. If both investors are money management professionals, the latter may also have a happier clientele (90 percent of the time, they will be doing better) and thus a more successful company. This may help to explain why risk avoidance is not the primary focus of most institutional investors."

 

Concentrating one's portfolio in 3 stocks may produce high alpha, but what if that is not my goal. May be my goal is just loss-avoidance and to compound at a reasonable rate.

[coc]

Did you see Eye4Valu's comment. Buffett devoted a section in 2004 letter titled "Portrait of a Disciplined Investor", saying Lou's picks had produced an average return of 20% compounded since 1980. Did he also have dollar signs in his eyes? I am leaving super concentrated investing to the geniuses. No, thank you. 15-20 stocks are concentrated enough for me to get alpha without blowing up completely on a single error.

 

Yes, I think he did. Smart people aren't immune to mistakes. It's unfortunate that so many great people got caught up in it. I respect Lou Simpson as much as anyone.

 

Again, you're taking this as me criticizing your personal methodology. I'm not - whatever you're comfortable with is completely personal. But you started by generalizing, by saying "Everyone should leave 3 stocks to Munger", which I challenge. I think there's a lot of nuance missing in the "3 stocks = risky, 20 stocks = comfy" line of thought, nuance that Buffett, Munger, and some others appreciate and have discussed, but seems to go over a lot of smart heads.

 

You guys are throwing statistics at me -- I know the stats. Math is math. But no one is engaging the point I'm trying to make about portfolio construction being intimately linked to the risks you take with each individual position. 3, 4, 5, 20 stock portfolios are not built alike. But everyone wants numbers, no one wants to actually think about risk. There are ways to reduce risk besides adding positions.

 

Coincidentally, I think up until VRX, Ruane Cunniff did this really masterfully. Their concentrated positions over the years have worked wonderfully with very limited risk. But the world got harder and they decided to take risk instead of accepting the possibility of lower returns. (Whether they were cognizant of it or not.) It's very, very interesting and I think at least partially linked to the pressures of managing money professionally, which gives individuals a leg up in this department.

[original mungerville]

Its the position size at Sequoia that was the main problem with Valeant, especially combined with Valeant's debt leverage.

 

If you think about Valeant's fall in Enterprise Value, its probably down about 60-70%. That enterprise value would have probably fallen less without leverage because baked into the fall in enterprise is a probability of liquidation at this point. So one might argue that without leverage, ie all equity, enterprise value would be down 50-60% because there would be zero probability of liquidation. Compare that 50-60% drop to the current 85% drop in the stock price. I mean the average stock on the NYSE fluctuates what, 30-40% a year? So 50-60% is really nothing much.

 

But with a 30% position and debt leverage at Valeant making the drop 85%+, I think that was the real killer. Every great investor has been, can be, and will be wrong on any number of investments. IF you weighed them at 10% of your portfolio, but ensured they had little debt, low operating leverage and had consistent earnings through economic cycles, along with competitive advantages, then the price of any of them might move no greater than 50% - so a 5% loss to the portfolio on a MTM basis is the worse you are probably going to get with very low risk of permanent capital loss.

 

A 20-30% weighting in Valeant with its high debt load in a public mutual fund is another story. I think Lou Simpson might have had 10% of his portfolio in it or something along those lines - so lets say he lost 8%. Hurts, but it is not a huge deal: he can likely make that up in 12 months. It won't really significantly interrupt his compounding process.

 

Ackman on the other hand decided to go big on Valeant, double down, and then even sell puts to fund calls, and on top of that, invested in other arguably correlated investments: other "platform" companies (which also do poorly if the junk bond market tanks) and/or other pharma companies. Imagine if we now have a real bear market in stocks with junk bonds going south significantly from here? Where would Ackman end up?

 

 

 

 

[Guest Schwab711]

I know that biggest parts of Buffett philosophy is to make huge big bets on a few ideas. That's great. I am not a Buffett or Munger. I am the above average poker player who does not want to lose my bankroll and live a long life. As long as I don't get pushed out of the game, compounding will take care of the rest. I don't aspire to be the next Buffett (because I know I am not that smart).

 

Couldn't agree more. Slow and steady is the way to go for 99.99% of all investors. By owning a three stock portfolio you are basically saying that you make no mistakes. That's not something I would like to bet my retirement money on - I'd prefer not to go broke if I am not as smart as I think I am. Also, you should consider the utility of all possible outcomes. Suppose you can choose between the following (simplistic) scenarios:

 

3 stock portfolio:

90% chance of 20% return p.a..

10% chance of going broke.

 

20 stock portfolio:

90% chance of 10% return p.a.

10% chance of 2% return p.a.

 

Obviously, on average the first strategy is way better. However, depending on your age, job and portfolio size you should be extremely worried about going broke. The second strategy might be your best pick unless you are 18 (or you know for sure you are a genius).

 

You could argue that you can buy 3 Berkshire-like companies and that your 'look-through' portfolio is reasonably diversified. In that case I might agree but such a portfolio wouldn't outperform the market by a huge stretch anyway.

 

One of my favorite investment lesson is from the chapter "Defining your Investment Goals" from Seth Klarman's book "Margin of Safety".

 

"Table [below] shows the delightful effects of compounding even relatively small amounts.

 

Compound Value of $1,000 Invested at Different Rates of Return and for Varying Durations:

Rate	5 Years	10 Years	20 Years	30 Years
6%	1,338	1,791	3,207	5,743
8%	1,469	2,159	4,661	10,063
10%	1,611	2,594	6,727	17,449
12%	1,762	3,106	9,646	29,960
16%	2,100	4,411	19,461	85,850
20%	2,488	6,192	38,338	237,376

 

As the table illustrates, perseverance at even relatively modest rates of return is of the utmost importance in compounding your net worth. A corollary to the importance of compounding is that it is very difficult to recover from even one large loss (emphasis mine), which could literally destroy all at once the beneficial effects of many years of investment success. In other words, an investor is more likely to do well by achieving consistently good returns with limited downside risk than by achieving volatile and sometimes even spectacular gains but with considerable risk of principaL An investor who earns 16 percent annual returns over a decade, for example, will, perhaps surprisingly, end up with more money than an investor who earns 20 percent a year for nine years and then loses 15 percent the tenth year. There is an understandable, albeit uneconomic, appeal to the latter pattern of returns, however. The second investor will out-perform the former nine years out of ten, gaining considerable psychic income from this apparently superior performance. If both investors are money management professionals, the latter may also have a happier clientele (90 percent of the time, they will be doing better) and thus a more successful company. This may help to explain why risk avoidance is not the primary focus of most institutional investors."

 

Concentrating one's portfolio in 3 stocks may produce high alpha, but what if that is not my goal. May be my goal is just loss-avoidance and to compound at a reasonable rate.

 

I think what coc is saying is that if you are going to concentrate in a handful of stocks or so then your investments wouldn't have a 10% chance of going to $0 (or even 1%). The concentrated investing hypothetical above is correct if the chance of $0 really is ~10%. However, that isn't "investing" in the first place, it's speculating. I think the difference in risk between 1997 Pier 1 and 1997 Wal-Mart was probably more than an order of magnitude, that's the point. Finding quality really isn't as hard as it seems. I'm not sure why folks assume you need to be a genius to do it but maybe it's because there's no fool-proof identification method?

 

I agree that "leave it for geniuses" seems like a cop-out. I'm not saying concentration is the best allocation strategy for everyone or anyone, but I would guess there is noticeably more risk (pdf has lower peak) in holding three average to below-average companies at 1/3 allocations as opposed to one large allocation of MCO or MA. There are some companies that have an obviously wonderful business model. I would also argue that a lot of diversification is not nearly as effective as perceived since co-variance between companies is greater than most assume. I could cite the Klarman table as evidence since high-quality stocks generally have less steep declines.

 

Someone should start a thread if folks want to continue this.

[rishig]

I know that biggest parts of Buffett philosophy is to make huge big bets on a few ideas. That's great. I am not a Buffett or Munger. I am the above average poker player who does not want to lose my bankroll and live a long life. As long as I don't get pushed out of the game, compounding will take care of the rest. I don't aspire to be the next Buffett (because I know I am not that smart).

 

Couldn't agree more. Slow and steady is the way to go for 99.99% of all investors. By owning a three stock portfolio you are basically saying that you make no mistakes. That's not something I would like to bet my retirement money on - I'd prefer not to go broke if I am not as smart as I think I am. Also, you should consider the utility of all possible outcomes. Suppose you can choose between the following (simplistic) scenarios:

 

3 stock portfolio:

90% chance of 20% return p.a..

10% chance of going broke.

 

20 stock portfolio:

90% chance of 10% return p.a.

10% chance of 2% return p.a.

 

Obviously, on average the first strategy is way better. However, depending on your age, job and portfolio size you should be extremely worried about going broke. The second strategy might be your best pick unless you are 18 (or you know for sure you are a genius).

 

You could argue that you can buy 3 Berkshire-like companies and that your 'look-through' portfolio is reasonably diversified. In that case I might agree but such a portfolio wouldn't outperform the market by a huge stretch anyway.

 

One of my favorite investment lesson is from the chapter "Defining your Investment Goals" from Seth Klarman's book "Margin of Safety".

 

"Table [below] shows the delightful effects of compounding even relatively small amounts.

 

Compound Value of $1,000 Invested at Different Rates of Return and for Varying Durations:

Rate	5 Years	10 Years	20 Years	30 Years
6%	1,338	1,791	3,207	5,743
8%	1,469	2,159	4,661	10,063
10%	1,611	2,594	6,727	17,449
12%	1,762	3,106	9,646	29,960
16%	2,100	4,411	19,461	85,850
20%	2,488	6,192	38,338	237,376

 

As the table illustrates, perseverance at even relatively modest rates of return is of the utmost importance in compounding your net worth. A corollary to the importance of compounding is that it is very difficult to recover from even one large loss (emphasis mine), which could literally destroy all at once the beneficial effects of many years of investment success. In other words, an investor is more likely to do well by achieving consistently good returns with limited downside risk than by achieving volatile and sometimes even spectacular gains but with considerable risk of principaL An investor who earns 16 percent annual returns over a decade, for example, will, perhaps surprisingly, end up with more money than an investor who earns 20 percent a year for nine years and then loses 15 percent the tenth year. There is an understandable, albeit uneconomic, appeal to the latter pattern of returns, however. The second investor will out-perform the former nine years out of ten, gaining considerable psychic income from this apparently superior performance. If both investors are money management professionals, the latter may also have a happier clientele (90 percent of the time, they will be doing better) and thus a more successful company. This may help to explain why risk avoidance is not the primary focus of most institutional investors."

 

Concentrating one's portfolio in 3 stocks may produce high alpha, but what if that is not my goal. May be my goal is just loss-avoidance and to compound at a reasonable rate.

 

I think what coc is saying is that if you are going to concentrate in a handful of stocks or so then your investments wouldn't have a 10% chance of going to $0 (or even 1%). The concentrated investing hypothetical above is correct if the chance of $0 really is ~10%. However, that isn't "investing" in the first place, it's speculating. I think the difference in risk between 1997 Pier 1 and 1997 Wal-Mart was probably more than an order of magnitude, that's the point. Finding quality really isn't as hard as it seems. I'm not sure why folks assume you need to be a genius to do it but maybe it's because there's no fool-proof identification method?

 

I agree that "leave it for geniuses" seems like a cop-out. I'm not saying concentration is the best allocation strategy for everyone or anyone, but I would guess there is noticeably more risk (pdf has lower peak) in holding three average to below-average companies at 1/3 allocations as opposed to one large allocation of MCO or MA. There are some companies that have an obviously wonderful business model. I would also argue that a lot of diversification is not nearly as effective as perceived since co-variance between companies is greater than most assume. I could cite the Klarman table as evidence since high-quality stocks generally have less steep declines.

 

Someone should start a thread if folks want to continue this.

 

Schwab, I don't think the problem is solved by having allocation to high quality stocks. If I had owned 30% of my portfolio in BRK, I may not have done as well as having 30% of my portfolio in MA. I have held a portfolio of high quality stocks mostly (about 60-70%) of my portfolio in about 6-8 positions, with the rest being in lower quality names as smaller position, for the last 10 or so years.

 

I have just been surprised by the ones that have performed well vs. the ones that did okay. I bought DIS in 2011 when it dropped to $28. I knew it was at historical low valuation and was expecting that it would be a 2x in 5 years. I was surprised to see how well DIS performed business wise and the stock was up 5x. If I knew apriori which ones are going to be the best performing one(s), I would have a 1 stock portfolio. I think this is beyond me and I will "cop-out" to owning my 10-20 stock porfolio (unless someone can teach me how to identify the winners).

[original mungerville]

I put 10% of my good friend's retirement portfolio in Valeant pretty close to the top - but I understood there was risk (not quite 85%+, but I had figured it could drop 50%). In any case, we sold when I couldn't figure out anymore whether or not it was still a buy - so we sold at a 50% loss and he did not ride this all the way down. He lost 5% of the portfolio. But 5% is easily salvageable over time.

 

And in this case, actually, it took us about 3 months to make that up. Maybe a bit of luck, but maybe not because I knew there was risk in the market generally stemming from macro pressures building and so Valeant was our only exposed equity position. In November, I put half his portfolio in cash, the other 35% or so in undervalued equities fully hedged against the market, and the last 15% in precious metals and precious metal miners.

 

Lou Simpson will have a similar outcome. Ackman (with his somewhat more correlated positions) and Sequoia with the huge sizing problem are in a different spot on this one however. What they don't need now is a full-on bear market.

[Kiltacular]

i don't think reducing the size of brk at that time was a problem or a wrong move. they explained it at the time of the decision. they know that company exceedingly well and had determined that it no longer was a compelling value at the price, and not worth a 35% allocation. they had identified a number of opportunities that they believed could add value at a faster clip than Berkshire.

 

This should make sense.  But, they bailed on Buffett.  Buffett seems to really care about loyalty.  Ruane seemed to understand that.  One (Buffett) could make the case that Sequoia exists because of him.  He shouldn't care about this stuff as much as he does, in my opinion.  But, I think he cares about it quite a bit more than Sequoia realized.

 

Munger made his comments at the Daily Journal meeting and Buffett put a whole section in the annual letter last year about roll-ups.  These were warnings in my opinion.  Then, Buffett loyalists Osberg and Lowenstein resigned. 

 

I think Sequoia should have seen that the writing was on the wall for Valeant and, at the very least, what would happen to Sequoia (in particular) if the Buffett group was correct.  It can be argued the management at Sequoia has suffered more than anyone else.  Abandoning Buffett was the big mistake -- I think it's the real reason Munger chimed in (in spite of his 'protesting' otherwise at this year's Daily Journal meeting).

 

If Sequoia was going to sell Berkshire, they should have waited until Buffett was gone -- no matter how poorly they thought Berkshire was going to do.  If they had, I don't think this would have gotten so bad for them -- I don't think Munger would have said what he had when he did.

 

It shouldn't have been that way and for that I can sympathize with Sequoia's management.  But, like I said, in my opinion, you don't mess with Buffett if he's been loyal to you for 40+ years and sowed the seeds for your existence and was a huge reason for your performance in your first two decades in business.

 

Some day, I predict, Ackman will wish he hadn't made his comments about Buffett and Coke.  His only hope is that when his time comes, Buffett is no longer around.  Still, Sequoia was selling something different than Ackman is and had attracted a different investor base -- they neglected their particular customer base in a way that Ackman probably hasn't.  In any case, Buffett won't forget.

[ZenaidaMacroura]

Did you see Eye4Valu's comment. Buffett devoted a section in 2004 letter titled "Portrait of a Disciplined Investor", saying Lou's picks had produced an average return of 20% compounded since 1980. Did he also have dollar signs in his eyes? I am leaving super concentrated investing to the geniuses. No, thank you. 15-20 stocks are concentrated enough for me to get alpha without blowing up completely on a single error.

 

Yes, I think he did. Smart people aren't immune to mistakes. It's unfortunate that so many great people got caught up in it. I respect Lou Simpson as much as anyone.

 

Chalk it up to lack of experience on my part but I remember in 2014 glancing over Sequoia holdings and thinking of Valeant as having a good business model/good key person at the helm.  Valuation or debt levels might not have been comfortable on the upswing but the underlying looked like a decent business/strategy...  edit: If I remove all hindsight bias and was perfectly honest with myself that is what I thought circa 2014. 

 

 

 

 

Some day, I predict, Ackman will wish he hadn't made his comments about Buffett and Coke.  His only hope is that when his time comes, Buffett is no longer around.  Still, Sequoia was selling something different than Ackman is and had attracted a different investor base -- they neglected their particular customer base in a way that Ackman probably hasn't.  In any case, Buffett won't forget.

I think if ever, Ackman is well at that point.

[coc]

Chalk it up to lack of experience on my part but I remember in 2014 glancing over Sequoia holdings and thinking of Valeant as having a good business model/good key person at the helm.  Valuation or debt levels might not have been comfortable on the upswing but the underlying looked like a decent business/strategy...  edit: If I remove all hindsight bias and was perfectly honest with myself that is what I thought circa 2014. 

 

I don't mean to be disrespectful but many people were discussing deep warning signs by 2014. Around the time of the Allergan bidding, summer of 2014, I had a PM convo with one well-known board member (who I generally respect and won't name out of respect) where I was questioning how it was possible that VRX could be buying companies at such astronomical prices and be getting 20-30% IRRs out of them. It was hard to see exactly what was going on and I couldn't really put my finger on the problem, but all I (and many others, if you look back in this thread) could tell was that they were claiming to do something that seemed impossible. The leverage being used was almost beside the point. His response was essentially that Pearson was a brilliant capital allocator who you need to "get comfortable with qualitatively," which struck me as more/less hand-waving an important issue.

 

And here we are now.

 

Which I say not to toot my own horn, but to hopefully point out that risk isn't just a hindsight thing - you can see it if you're looking for it. I think the problem is that investors put it aside when everything is going well. They basically hand-wave the problems. Enron had a lot of years when all of its ridiculous financial machinations looked pretty good, when Ken Lay and Jeff Skilling were Harvard geniuses, not prisoners. Chesapeake was written up in OID as a brilliant, undervalued long just a few years ago, but believe me, in both cases, the risk was there. The common thread between these three companies, at least, was that the cult of personality around the executives obscured some of the basic truths.

[ZenaidaMacroura]

Chalk it up to lack of experience on my part but I remember in 2014 glancing over Sequoia holdings and thinking of Valeant as having a good business model/good key person at the helm.  Valuation or debt levels might not have been comfortable on the upswing but the underlying looked like a decent business/strategy...  edit: If I remove all hindsight bias and was perfectly honest with myself that is what I thought circa 2014. 

 

I don't mean to be disrespectful but many people were discussing deep warning signs by 2014. Around the time of the Allergan bidding, summer of 2014, I had a PM convo with one well-known board member (who I generally respect and won't name out of respect) where I was questioning how it was possible that VRX could be buying companies at such astronomical prices and be getting 20-30% IRRs out of them. It was hard to see exactly what was going on and I couldn't really put my finger on the problem, but all I (and many others, if you look back in this thread) could tell was that they were claiming to do something that seemed impossible. The leverage being used was almost beside the point. His response was essentially that Pearson was a brilliant capital allocator who you need to "get comfortable with qualitatively," which struck me as more/less hand-waving an important issue.

 

And here we are now.

 

Which I say not to toot my own horn, but to hopefully point out that risk isn't just a hindsight thing - you can see it if you're looking for it. I think the problem is that investors put it aside when everything is going well. They basically hand-wave the problems. Enron had a lot of years when all of its ridiculous financial machinations looked pretty good, when Ken Lay and Jeff Skilling were Harvard geniuses, not prisoners. Chesapeake was written up in OID as a brilliant, undervalued long just a few years ago, but believe me, in both cases, the risk was there. The common thread between these three companies, at least, was that the cult of personality around the executives obscured some of the basic truths.

I don't offend easily  :D

 

I figured it was mostly pricing power exercised on portfolio of products that had mostly already been tempered by generic sales drop off.

 

I mean some of the things you say would make me weary of other much loved companies (TDG?  or closer to home Allergan?)

[Patmo]

Agreed, 20ish stocks is a great sweet spot imo between concentration and diversification. The number one mistake in this game is blowing up on big bets, you see it all the time... overconcentration is a way worse sin than overdiversification, one might drag down your compounding a few basis points, the other might drag down your entire life and family to the gutter. Easy decision, and a 20ish stock book is not that hard to build considering there are thousands of publicly traded businesses so there is no excuse. That's like 4 stocks a year with a 5yr holding period...

[Guest wellmont]

they didn't "bail" on buffett. that's a sentimentality. they sold some of the stock because it was fully valued. I read their explanation at the time. and it made complete sense coming from people who know the company probably almost as well as buffett does. besides they still own a 10% position, which is way more than most funds own. it's rare that a fund even owns any berk.

 

by this rationale anybody that doesn't own berkshire has "bailed" on buffett and is not "loyal". there are times that buffett himself has told people that berk is overvalued. that's a signal to sell some stock if you need some cash. he also tells people if you want a dividend sell 5% of your stock every year. investing is not about sentimentality.  nor is it about a cult of personality. it's about being rational and making good decisions. the rcg vrx experience was not about being "punished" by the investment gods because they bailed on a deity.

 

in Hindsight the big mistake was falling in love with MP. the rcg cio thought that mp could add value even at $250 a share for vrx. that's how strong the belief was. believers in mp were fooled. not that he wasn't brilliant. he was. but there were negative aspects of his personal makeup that worked against his intelligence, and eventually brought down this company. malevolent incentives played a role as well.

 

disciplined investors don't make decisions based on what other people say with their off the cuff remarks. they make their own decisions. cm turned out to be right here. but he didn't know the situation very well. his instincts and his bs detector are impeccable. the bs detector is the most underrated skill in the investor tool kit.

 

the lesson here is that bad things can happen in the capital markets to even the smartest and hardest working people. because we are human we are all subject to bias and influence. the lesson for all of us should be to become even more humble about our work, and to understand that given enough time bad things in investing can and will happen to the best of us.

 

ps: there were a lot of people here who were not fooled by mp. and they are to be congratulated for seeing things that others missed.

[Guest Schwab711]

no they didn't "bail" on buffett. that's a sentimentality. they sold some of the stock because it was fully valued. I read their explanation at the time. and it made complete sense coming from people who know the company probably almost as well as buffett does. besides they still own a 10% position, which is way more than most funds own. it's rare that fund even owns any berk.

 

by this rationale anybody that doesn't own berkshire has "bailed" on buffett and is not "loyal". there are times that buffett himself has told people that berk is overvalued. that's a signal to sell some stock if you need some cash. he also tells people if you want a dividend sell 5% of your stock every year. investing is not about sentimentality.  nor is it about a cult of personality. it's about being rational and making good decisions. the rcg vrx experience was not about being "punished" by the investment gods because they bailed on a deity.

 

They had 30-40 years of history with Buffett. Extrapolating comments about Sequoia/Buffett to other firms makes no sense because they don't have 30-40 year relationships with Buffett.

 

in Hindsight the big mistake was falling in love with MP. the rcg cio thought that mp could add value even at $250 a share for vrx. that's how strong the belief was. believers in mp were fooled. not that he wasn't brilliant. he was. but their were negative aspects of his personal makeup that worked against his intelligence, and eventually brought down this company. malevolent incentives played a role as well.

 

disciplined investors don't make decisions based on what other people say with their off the cuff remarks. they make their own decisions. cm turned out to be right here. but he didn't know the situation very well. his instincts and his bs detector are impeccable. the bs detector is the most underrated skill in the investor tool kit.

 

We have no idea how "well" Charlie Munger knew VRX. He was one of the first to call them out publicly so I'd imagine he knew them pretty well (better than most on this board even). Considering he is in the spotlight, I'd imagine he didn't expound his VRX comments because he gets nothing for being right and a lot of problems if he is wrong about anything. Kiltacular's post is probably pretty close to the truth considering how well it fits with what we know and what is likely true about the involved characters.

 

the lesson here is that bad things can happen in the capital markets to even the smartest and hardest working people. because we are human we are all subject to bias and influence. the lesson for all of us should be to become even more humble about our work, and to understand that given enough time bad things in investing can and will happen to the best of us.

 

An alternative lesson, not all equity investors have the same incentives and/or payoff tree as the average investor. The incentives to act on an investment idea at a hedge fund are so drastically different from the incentives to act for the average COBF board member that their investment decisions/positions should be considered irrelevant. Portfolio managers at HFs will often be compensated extremely generously regardless of outcome. If your retirement portfolio is in the same situation than maybe you could consider cloning or using their ideas as a starting point for research.

[coc]

I mean some of the things you say would make me weary of other much loved companies (TDG?  or closer to home Allergan?)

 

Now you're thinking!  :)

 

(As a disclaimer, I have no real strong opinion on either of those, but I want to encourage people to follow their noses instead of trusting other's noses.)

[Guest roark33]

Today's filing is classic VRX. 

 

We are seeking an extension of time to file 10-k and 10q and, oh by the way, also some relief on our interest coverage ratios.  That second part is probably how it is going to be for the rest of the way down, more and more bad news....

[Picasso]

Today's filing is classic VRX. 

 

We are seeking an extension of time to file 10-k and 10q and, oh by the way, also some relief on our interest coverage ratios.  That second part is probably how it is going to be for the rest of the way down, more and more bad news....

 

I saw that interest coverage waiver tucked in there and thought, are you freaking kidding me?  How much are they going to pay for those amendments?  I thought this was supposed to be a business that generated a ton of "cash earnings?"  We're not even talking about the amortization expense yet.  How exactly are the bondholders supposed to react to that kind of request?  The covenants were loose enough as it was, allowing them to take on $31 billion of debt for a bunch of assets they overpaid for. 

 

Generating $31 billion of real after-tax cash is hard.  People will look back and say "they took on how much debt to buy what again?!?"

[AzCactus]

Isn't the bottom line here to be wary of debt generally and make sure you trust the management of a company enough to date your only daughter?  I have no dog in this race but to me Pearson had been really aggressive (and arrogant) in terms of growth.

[randomep]

Agreed, 20ish stocks is a great sweet spot imo between concentration and diversification. The number one mistake in this game is blowing up on big bets, you see it all the time... overconcentration is a way worse sin than overdiversification, one might drag down your compounding a few basis points, the other might drag down your entire life and family to the gutter. Easy decision, and a 20ish stock book is not that hard to build considering there are thousands of publicly traded businesses so there is no excuse. That's like 4 stocks a year with a 5yr holding period...

 

Yes, I have grappled with this topic many a time.  The first idea I got was from "Random Walk Down Wallstreet" and the 2 basic things I remember are: low PE stocks perform better than high PE stocks, and 12 stocks is sufficient to get the benefits of diversification, beyond that there is diminishing returns.  To anyone who says how can you filter out VRX, well VRX doesn't even have a true PE, so I filter it out basically on PE.

 

Ok back to the number of stocks, so I am virtually all out of mutual funds. And I have 20 stocks, so I am close to 12.  I need this many partly because they are small caps. And 20 is about the maximum I can keep track of with a full time job.  I am in my 40s now but if I have a nest egg at 60 worth say (I am picking a random number out of the hat here) $5M, I cannot imagine just owning 20 stocks. Because that would mean an average position of $250 and the max position would probably be $500k at least! I cannot image losing several years salary on one mistake!  So I think I will have a cap on the average position size.  If that means I must own 40 or 50 samll cap stocks, so be it.  Or I can combine 10 of my stocks into one Brk. Concentration on Brk is totally fine by me.

 

 

[doughishere]

Can anyone here tell me what the accounting "issue" is that VRX is facing? Hint: it's not too much debt.