More on buy and hold forever results

Investment Analysis Clubs Saul’s Investing Discussions
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An interesting recent post by huddaman on a MF SA board:

If I look at David’s side of the portfolio … he ended up with 6 recommendations of Disney, and they total 31.81% of his virtual portfolio….DIS, PCLN, NFLX, AMZN combined rule 75% of his scorecard today. They are 16 positions out of a total 157 so far, and they rule the scorecard. Any new recommendation today is 0.02% or so of his portfolio. I guess if any of the new recs became 10-baggars, they would have a slight impact. . It’s an interesting portfolio dynamic. David knows this. I am not criticizing. I am just pointing it out. Huddaman

It’s really quite a statistic. Disney is a third of the whole portfolio that they are figuring results on. Add in Priceline, Netflix and Amazon and it’s 75% of the portfolio. All the rest of the more than 100 recommendations average about a quarter of a percent each! It’s all about Disney. Disney is the tail that wags the dog, and David’s results are basically Disney’s long rise from $1.94 to $105.00. How a new recommendation does is totally irrelevant as it’s roughly 1/100th the size of Disney.

This reminded me of my post from February, since Huddaman got about the same figures I did. Here’s my post (slightly edited and shortened:

Back in 2002, David recommended Disney. It was a great recommendation and is now up 5316%. In fact he recommended it again in 2002, twice more in 2003, again in 2004, and a final sixth time at the bottom of the great recession in Dec 2008. They all did great. (Some people have pointed out to me that some of these recommendations were recommendations of other companies that were then acquired by Disney, but that is irrelevant for the point of the argument)

If we think of this as a portfolio, and each of the six recommendations as a $1 investment (for simplicity), here’s what they are worth now:

1st rec of $1 – up 5316% - now worth $54.20
2nd rec of $1 – up 3271% - now worth $33.70
3rd rec of $1 – up 933% - now worth $10.30
4th rec of $1 – up 709% - now worth $8.10
5th rec of $1 – up 1246% - now worth $13.50
6th rec of $1 – up $543% - now worth $6.40

The whole six recommendations, which cost $6, are now worth $126.20 (up 2000%).

David made about 100 recommendations in total. His portfolio is listed as up 257% so the way I figure it, his 100 initial $1 recommendations are thus worth $357, of which $126.20, or 35.4% is Disney. The other 94 recommendations make up $231 or 64.6% (or about two-thirds of a percent each). What’s wrong with this picture?

Well, any new recommendation is only worth $1, and Disney is worth $126, so whether a new recommendation moves up or down influences the David’s Portfolio gain infinitesimally. Even if it doubles, or drops to zero. It’s all about Disney and some other purchases that were made in 2002 to 2004. (Amazon, Activision, Priceline and Netflix) that now make up large parts of the portfolio.

So what does that mean for someone who joined after 2004? That since 2004, things haven’t gone nearly as well? That David’s high percentage is basically a reflection of Disney’s rise from $1.94 to $105.00?

Now, that may seem cynical, but it’s just the numbers. Buy and hold and never sell is great if you happened to buy Disney and the others in 2002 to 2004. If you didn’t, who knows? It’s an entirely different calculation that we don’t have. As Huddaman also said in his post

For an investor to benefit from this newsletter, they might have to buy almost all the recs, and resist any and all temptations to double down or improve the cost basis. BTW, I wish this was apparent and obvious to me when I first got introduced to this newsletter.

This should stimulate some discussion.

Saul

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What an interesting observation.

I am glad I have some Disney in my portfolio!!! (and it’s up 10.5% YTD).

Karen

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It also makes sense that DIS is one of the starter stocks. Perhaps buying only the starter stocks would be a good strategy for SA and/or RB.

Karen

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David’s portfolio is an example of the Pareto distribution, the distribution wealth normally assumes, albeit a bit more exaggerated than the distribution of wealth Pareto observed in Italy which was closer to 20/80: 20% of the population owned 80% of the wealth. In David’s portfolio 10% of the stocks represent 75% the wealth.


  0.64%   31.81%
 **10.19%   75.00%**
100.00%  100.00%

This is what normally happens to any portfolio if you don’t rebalance it. There are two schools of though. Modern Portfolio Theory (MPT) rebalances to reduce volatility while Peter Lynch advised not to cut your flowers and water your weeds which grows the portfolio faster at higher volatility.

The Pareto distribution is everywhere. In inventories, 20% of the parts represent 80% of the transactions, in sales 20% of customers produce 80% of the revenue, and so on. It’s also called the long tail.

In a portfolio like David’s you would have an entry position size, say with 157 stocks it might be 1% of the portfolio. Then you let the stocks fight it out. When you rebalance you sell your best gainers. That’s the price you pay for reduced volatility. If you run a mutual fund you want low volatility to keep investors on board but the fund pays for it in reduced long term results. For an individual investor with sufficient funds and a long term outlook, volatility should not be a problem.

I’m not advocating “Hold for Ever” or “Buy and Forget.” Back to Peter Lynch: “Sell when the story changes.”

Denny Schlesinger

An example of the Pareto distribution at work:

Why Does the Average Mutual Fund Underperform?
http://softwaretimes.com/files/why+does+the+average+mutua.ht…

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It also makes sense that DIS is one of the starter stocks.

When I looked at Disney, it was a long time ago, I was not impressed. DIS has had a great run since 2009. I wonder when David bought. Also, David is taking into account several stocks that were merged into Disney. It could well be that extraordinary performance is not Disney per se but the companies they bought (Pixar, etc.).

http://invest.kleinnet.com/bmw1/stats40/DIS.html

When I looked at Disney (around 2005) the situation was very uncertain with lots of infighting

1984–2005: The Eisner era and the Save Disney campaign
http://en.wikipedia.org/wiki/The_Walt_Disney_Company#1984.E2…

Denny Schlesinger

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Saul,

I think you will find this discussion comes up quite a bit in both the SA and RB boards. The primary request tends to be to adjust the reporting/marketing that is done to reflect percentage gains across different time periods versus just the recommendations as a whole from the beginning. I certainly see value in that myself, but as you, Huddaman, and many others have done, the numbers are all public for SA subscribers to do the math themselves and see where the majority of the gains are coming from. This can also be done with your portfolio as well as you have been quite generous to share that with us on your board. But it certainly complicates things when you are a company selling services and presenting the numbers in the most positive light for marketing purposes comes into play.

I definitely agree with you that it seems unrealistic that an individual would let DIS alone become such a large percentage of their portfolio. I think the point behind the article and the math is that they would be better off if they did even though the risk would be off the charts. The same might be true with your stocks as well if you could stomach the risk over that long a period of time. I for one could not and would tend to trim by best along the way to “adjust my risk”, but is that right? I think so because it lets me sleep at night, but sometimes it does feel like you have to limit your own performance to adjust away from concentration risk.

Your portfolio is a great example I think. You are more concentrated than many others since you have great confidence in your ability to analyze companies. And you are sharing that here with us on your board. But I would guess that early in your investing career, you were not as confident while you were building your knowledge and diversified much more to lower your risk. I think I have read you have adjusted the number of companies down in your own portfolio over the years down to what you have now as your experience has grown. I want to get there myself, but it feels like that is a progression. I started with just index funds and eased into individual stocks. I am diversified broadly right now creating my own “index fund” from the TMF universe, but that is not likely to perform as well as your more concentrated and well researched portfolio. Over time I will gain more confidence about how to better analyze companies and greater concentration will occur.

But getting back to the original point. SA and RB are idea services first and foremost. Not portfolios. The marketing certainly hints that they are portfolios in some way, but people can do very well or very poorly based on their own choices from the SA/RB ideas. TMF could absolutely do better I think with decision making on when to sell and how long to hold ideas that are not panning out, but I do like that they track their ideas for a long period of time as you can learn quite a bit from their mistakes as well.

Thank you for asking these questions and presenting your views on portfolio management as well. Very helpful board and discussion.

Tom

Tom

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I wonder when David bought. Also, David is taking into account several stocks that were merged into Disney. It could well be that extraordinary performance is not Disney per se but the companies they bought (Pixar, etc.).

That’s exactly what it is - David never recommended DIS on its own, rather He recommended companies that were acquired by Disney and recommended that Fools that held them take the DIS shares at the time of buyout.

MVL
MVL
Pixar
Pixar
MVL
MVL

between 2002 and 2008.

Greg

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Your portfolio is a great example I think. You are more concentrated than many others since you have great confidence in your ability to analyze companies. And you are sharing that here with us on your board. But I would guess that early in your investing career, you were not as confident while you were building your knowledge and diversified much more to lower your risk.

Actually when I was starting out it was the opposite. I had much less money to invest. Also I could tolerate risk better as I was still working and could replace losses if necessary, so at times I had as few as six or eight stocks if my memory doesn’t fail me. Now I’m more comfortable with 15 to 20. You can grow much faster with a smaller number, but, as you say, there’s a lot more risk.

Saul

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SA and RB are idea services first and foremost. Not portfolios. The marketing certainly hints that they are portfolios in some way, but people can do very well or very poorly based on their own choices from the SA/RB ideas.

That’s a nice explanation.

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Buy and hold and never sell is great if you happened to buy Disney and the others in 2002 to 2004. If you didn’t, who knows? It’s an entirely different calculation that we don’t have.

I thought this was an interesting point too. No one joins and buys all previous recommendations. They probably buy a few current recommendations, and maybe one or two best buys, and a couple of starters. And if something was recommended six times in the past, no one buys six times as much of it. And those recommendations have already grown to many times six initial purchases, and you can’t go back and capture those gains from 2002. What about someone who joined in 2006, or 2010, or 2013? What kind of results did they get if they only bought current recommendations? That’s a whole different set of calculations, which wouldn’t be nearly as good for marketing.

Saul

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That was one thing that really frustrated me when I first joined MF. The best winners already looked like they were too far extended to buy and some were not being re-rec’d and had quiet boards.

I still had some good winners from MF over the years, but also a lot of duds. I think the core/starter stock thing has helped that. I still think it is worth it as an idea list of potential buy points, but it is definitely not a portfolio, and is a bit misleading to quote performance vs the market as such IMO.

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Seems to me that things could be made clearer, or at least enhanced, by showing CAGR numbers:

  • for each pick
  • for each year (?)
  • for the portfolio as a whole

If we had these numbers to look at, then last year’s “50% gain” on a stock is excellent, even when compared with a 10-year old pick up x000% (very roughly speaking).

Once upon a time I was tracking that for the services I subscribed to, but I stopped doing that a number of years ago.

-FrickNFool

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Seems to me that things could be made clearer, or at least enhanced, by showing CAGR numbers:
* for each pick
* for each year (?)
* for the portfolio as a whole

Hi FrickNFool,

While up 257% sounds much more exciting for advertising, if you figure it back 13 years to 2002, the CAGR for David’s half of MF SA comes to roughly just 10% per year.

Saul

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What about someone who joined in 2006, or 2010, or 2013? What kind of results did they get if they only bought current recommendations?

Timing is everything. Not all recs are equals.

I started moving from mutual funds to SA recs in early 2011. By the end of the year I was done with the idea that I needed to buy small portions of every rec. and I started to let my feelings on each one marinate for a few months before buying any.

Out of curiosity I just took a look at the SA recs from 2011. I didn’t take the time to calculate anything but a quick glance at the vs. S&P column looks like SA, along with myself, got spanked by the market.

I added RB to my subscription in 2012. Have had a number of multibaggers since. Out of curiosity I just took a look at RB recs from 2012. Again, I didn’t take the time to calculate anything but a quick glance at the vs. S&P column looks like RB recs are ahead since.

More curiosity and I took a look at each service in the opposite two years. Looks like RB recs might be even to slightly up since 2011 and SA recs up in 2012 vs. S&P with the same quick uncalculated glance.

So I’m doing much better now since my initial start to picking individual stocks. Is this because of general market conditions? Is it because I’m seeing a difference between some recs being able to perform? Is it because I have adjusted my philosophy based on my experience and mistakes? I hope it’s more of the latter vs. former or what’s the point of all this? I guess time will tell.

I do know that I have no need to hold onto things like AMRC, SINA, WPRT, YELP, XONE, CLNE and hope that their stories pan out for a umteenbagger to make up for the rest. Could it happen for one, sure but, I don’t need to anchor on the possibility of it. At the same time I’m thinking how can I not hold onto things like BOFI, AAPL, NFLX, FB. All of these companies are not the same. Some of them generate cash and grow and the stock performs, the others not so much.

Ray

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