Finding a great company early is hard. How hard? You don’t have to look much further than your investment heroes. Warren Buffett has owned hundreds of stocks over his career. He’s owned some for a few months. He’s owned most for a few years. He’s owned a dozen or so for 10+ years.
It takes the best investors in the world a few decades of owning hundreds of stocks to find a handful that are worth holding.
Time and turnover.
Most of the best stock pickers of all time were very active under the surface. You have to go on a lot of dates before you find your spouse. You have to kiss a lot of frogs to find a prince. You have to turn over a lot of rocks to find a great one. When you think you’ve found one only a small percentage of those will deserve to be held for more than a year or two. It is incredibly difficult to find a small emerging company that has the people, product, processes, and culture to scale, adapt, and survive over the long-term.
How many small stocks have you liked more the longer you owned them? Be honest. Not many. The great ones you like more as time goes on because vision + execution occur and this creates a flywheel of trust. Those are the rare ones. They ultimately become your largest positions because management executes, the stock goes up, and you realize you may have found a stock that is truly worth holding.
During a lifetime you will have 10-20 big winners and hundreds that didn’t live up to your expectations. Time and interest are the primary components of compounding. Identifying the losers in your portfolio is as important as holding winners because losers dilute your returns. Losers are a waste of time.
In 1984, Robert Kirby wrote a publication for the Journal of Portfolio Management titled “The Coffee Can Portfolio”. The coffee can term comes from a time in America when people used to keep their most valuable possessions in coffee cans under the bed. A coffee can portfolio is a term used to describe a “buy and forget”or “never sell” approach to investing. The coffee can approach solves too primary issues investors face. Getting scared out of big winners while lowering transaction costs, commissions, and taxes to the lowest point possible.
As stock pickers you hold big winners two ways:
- Coffee Can Portfolio. An “active” coffee can portfolio is when you put time, effort, diligence into the initial purchase but you take the sell decision out of the equation. This is a diversified (30+ stocks), never-sell portfolio, where you are investing 3% or less at cost into each position. You let your winners run and losers fall. You continue to follow the company progress and buy more on rare occasions. You can hold through the volatility because you never sell. Examples: The Motley Fool Approach (won’t sell) and PE/Venture Capital Approach (hard to sell). A “passive” coffee can portfolio is taking a very small position and forgetting that you own it. Some people do this annually in their self-directed retirement accounts when they make contributions. The small position allows them to live with the big gains as they grow and not lose much if they lose.
- Conviction Investing. Conviction is when you feel you know a business/stock better than the average investor in that business/stock. Conviction investors normally manage a concentrated portfolio (30 stocks or less) so they can focus on accumulating knowledge on their best ideas. The ultimate edge for conviction investors is their ongoing maintenance due diligence and keeping an accurate pulse on the company. They try to know what they own at all times. True conviction can only be obtained by trusting your own research over that of others. They do independent research to form independent conviction. They do the work, so they know when to buy. They do the work, so they know when to hold. They do the work, so they know when to sell.
Coffee Can and Conviction Investing are opposites. When you take the sell decision out of the investment process you don’t need conviction. You hope for the best and move on to the next one. Coffee Can views selling as a liability. Conviction Investing views selling as an asset.
The best part of public markets investing is variable pricing. Over the past 12-months Berkshire Hathaway A Shares have traded in a range of $393,000 – $531,000 per share. Almost every year the market will give you an opportunity to buy something you own 30-50% off the highs. My largest position, and our largest position at IFCM, was down 60% peak to trough over the last 18 months, and is now back near the highs. Already in 2023, we had a couple falling knives situations. In a matter of 48 hours both stocks dropped 40% for non-fundamental reasons. We scooped up more shares. Conviction allows you to be decisive when the majority are indecisive. One or two times per year you will get a no brainer price on a high conviction position.
“You just can’t copy other people’s insights. Sooner or later, the position turns against you. If you don’t have any insights into the business, when it goes from $100 to $50 you aren’t going to know if it will go back to $100 or $200”
When conviction investors evaluate new opportunities, they are constantly evaluating them against what they already own. A new opportunity can’t have similar upside to an existing position, it needs to have considerably more upside to replace the “trust” in what they already own. There is a time value in accumulating knowledge on a position. The best place for new capital is often times in an existing position. All you have to do is wait for that one time per year they go on sale. But eventually you will find something new that is exceptional – that forces you to sell your least convicted position.
The second-best part of public markets investing is you can sell. You don’t have to continue holding companies you no longer believe in. Especially in microcaps which are predominantly smaller, more fragile businesses where the spectrum of outcomes is wider. The risk of permanent capital loss is higher. Selling isn’t just prudent, it is necessary. You can’t coffee can microcaps.
It’s romantic to think you can be the Terry Smith of microcap and smallcap gloating about your low turnover, but this isn’t reality. You can’t say “I’m going to hold this stock for 1-5-10-40 years”. No, you are going to hold it as long as management executes. This could be 3 months, or it could be 30 years. This is what Buffett does with his public portfolio. Most of the companies you own today will only deserve to be rented. Ownership is earned.
If you invest in microcaps you will have turnover. You must have turnover. 20% of what you own today will likely deserve to be owned 5 years from today. This means that 80% of what you own today will deserve to be sold. My intention with every purchase is to hold forever but very few will earn that right.
Successful stock picking isn’t just picking winners. It also means picking out the losers in your portfolio. Warren Buffett wasn’t a coffee can investor. Most of the stock pickers you admire are conviction investors. They focus on finding the best opportunities, knowing them better than most, holding the ones that are worth holding, and selling mediocrity.
The ultimate goal for a conviction investor is to find a handful of businesses that become a self-driving portfolio (H/T Josh Tarasoff term). This occurs when you hold a business where the flywheel of management vision + execution keeps spinning year after year, decade after decade. You can’t force it. Conviction is a lot like love and trust. It takes time to develop and it needs to be earned. Just like Buffett and others – it will take 10-20-40 years of owning hundreds of stocks to find the select few that are worthy of you taking your hands off the steering wheel.
From 2001 to 2013 Nicholas Sleep and Qais Zakaria grew investor capital 921% versus 116% MSCI All World Index. A majority of this outperformance was simply holding Amazon, Costco, and Berkshire Hathaway. At the end of Nomad’s epic 13-year run they communicated to their partners they would ride out Costco, Amazon, and Berkshire until the end. They had such high conviction and trust in these businesses they were ready to take their hands off the steering wheel. They found their self-driving portfolio. There was nothing else to say or do or prove, so they gave their investor’s money back. An epic ending. It took them 10+ years and some turnover to find a handful of companies worth holding.
Time and turnover.
I don’t know if this is doable in microcap, but it’s a goal worth pursuing. I can only imagine how it must feel to reach that point where you’ve found that self-driving portfolio – when you can finally write to yourself or to your investors, “This is it. I’ve found them. I have nothing more to say or do or prove.”
What a day that will be.
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