Andrew:
I hope we can convince you to visit this thread more often, because your post was excellent!
I believe concentration is better than diversification, provided that one is working within one's "circle of competence."
A very good way of putting it. And I agree with you. But here is another way of looking at it: within a "circle of competence" which is greater concentration: 20% in one company, or 20% spread over say four companies? Either way you have 20% in a specific niche. And as you'll see in a minute, maybe, just maybe, valuations enter into it.
Like you, I've been influenced by Phillip Fisher as much or more than Buffet or Graham, so my advice would be to avoid the basket and to go with the few companies that you believe strongly in. I've gone with the basket approach when I've been unsure which company will perform best in a particular sector, and I've generally been disappointed with the results. Have always felt that had I'd either waited or put more time into studying the situation to pick the single winner I'd have been better off.
This pre-supposes two things: 1) that you are operating in a niche where there will be definite winners and losers, and 2) that you are truly capable of discerning which are which in advance.
I can't comment on the specific stocks you mention, because I haven't a clue about the ag equip business.
Actually that makes things better. I am interested in discussing methodological issues, not looking for help in picking an ag equip stock. In fact, I am glad that the ag equip makers are overall cheap right now, since it gives us a niche to discuss where SI participants are for the most part unlikely to have an emotional interest. I could have used examples out of the computer technology realm, but that would have led to distracting debates over the relative merits of each company, rather than on the analytical approach.
So for this discussion, don't worry about not being familiar with the ag equip manufacturers. Porc, Wayne and Berney are all city boys who don't know how to drive a tractor anyway. So I'll give ya'll just a little more background info, just enough to hopefully jumpstart some more discussion (but deliberately not enough to allow for an informed pick).
In terms of the businesses, I don't think we are considering an area where there will be definite winners and losers. All of them are a play on emerging markets, and any arguments you might make for emerging countries needing airplanes, you can apply to agricultural equipment (`course ag equipment is more affordable). All of these companies are purchasing smaller competitors around the world. All of them are repurchasing shares to some extent. (For example, take a look at biz.yahoo.com and
biz.yahoo.com.
Yes, some will do better than others in some areas. Case, for example, has equipment for well drilling that will hold up in strata that would tear the back end off of a Deere or Cat product. AGCO isn't as much a player in central Asia, but is gung ho in S. America. All of them have financing arms; Deere having the best financial strength is perhaps least hurt by an economic downturn (though I wish they would get rid of their health services unit). It seems reasonable to suppose that all of them will be around doing their thang, and somewhat larger, in ten years. So the question becomes, does the advantage of a very concentrated portfolio, which I consider to require the apparent safety of a Deere, outweigh the advantage of better valuation with multiple companies which are not cigar-butt companies, but are growing concerns, even if they aren't as dominant? Put another way, is there truly more safety in Deere's size and economic strength, or is there more safety in the lower prices of Case and AGCO? If so, does it outweigh the potential returns advantage suggested by the lower valuations in the two smaller competitors?
Let's put some approximate numbers on it. If my investment universe has an estimated coupon for the next year of 4%, Deere has an estimated coupon of 7.5%, Case has an estimated coupon of 11%, and AGCO has an estimated coupon of 15%, does it make more sense to buy Deere, or to split the money between AGCO and Case? Remember, I'm more interested in your reasoning than in your conclusion.
I am an absolute believer in staying with one's circle of competence, and its hard enough keeping up with the area I've chosen.
This raises an interesting side issue: how does one determine their circle of competence? Consider the often heard refrain "I don't understand technology." What does that mean? That they can't take the equipment back and put it together again? Got news for `em - they probably can't take apart their cars or refrigerators, and they probably can't explain how tires are made, and they probably have close to zero concept of the manufacturing problems inherent to airline assembly. Take a look at our ag equip companies. Both Case and AGCO are working on equipment that interacts with satellites for control. Caterpillar has a fuel injection / valve timing system in their labs that works so well that you might be willing to sit and inhale the exhaust fumes. How many understand these things? The potential benefits sure, but by that token, can't these people understand the benefits of at least certain improvements in electronic technology if the benefits are pointed out? Or they'll say "I don't understand how they make money." (Now there may be some doubts on this once you take options into account, but we're talking about the businesses.) Just like every other company - they produce a product and sell it. Continually decreasing results and increasing volumes? Sounds like textbook economics to me. "They disappear from business so often." Sure they do. So do retailers, and grocery stores, and machinery manufacturers. And boy can I remember the steel companies falling in trouble 15 years ago. The "tech" stocks tend to give more of a fireworks display first, so maybe they get more attention that way.
When you get into little niches, I think you do have to be an expert to really make out well. But I don't think Hewlett-Packard is any more mysterious than Deere, and they are both easier to figure out than a producer of primary materials. (Steel making "low tech?" Go visit Carpenter's and you'll come out singing a different tune.) OK, my off-topic rant is hereby ended.
I have a more general question to put to the thread: how to apply the wisdom of our collective gurus' to the area of high-tech investing. My own view is that Graham, Buffet,and Fisher provide a valid roadmap for high tech investing, except that the timeframes need to be shortened down to 18 - 24 months.
Well Fisher did and does invest in "tech." It is interesting to read his Common Stocks, Uncommon Profits and note what were the "tech" stocks of the time. But his guidelines for stocks selection and for portfolio management do give some decent ideas for how to invest in tech stocks for the long haul. And in fact, Fisher dances with the very topic of the above discussion. With a large, diversified growth stock, or "A companies" (my interpretation: a Hewlett-Packard, a Computer Associates) he suggests that you put no more than 20% into a given stock. He suggests that such companies should comprise the majority of your portfolio. With an up-and-comer "B company" (maybe a Parametric Technologies? or a Tellabs?) he cuts the limit per portfolio position in half. With the "C" companies in which, as he puts it, you can lose it all, not more than 5% per position. Fisher also (apparently unintentionally) suggests investing patterns analogous to the conservative and enterprising investors of Graham. The former should simply restrict himself to the Grade A companies, the latter may branch out into the B companies, and if they have some expertise, the C companies.
Why? Because the sector is characterized by a very rapid rate of change. Business fundamentals can change very quickly, and it is very tough to see very far down the road. This makes it impossible to
buy tech stocks "as if the stock market was going to be closed for the next 10 years" a la Buffet, or based on numbers alone, a la Graham.
One approach is to use the valuation methodology Hagstrom lays out in The Warren Buffett Way, but instead of using a 10 year growth period, use a shorter growth period. With a Hewlett-Packard or a Computer Associates, you should be able to use Value Line figures or your own and feel fairly comfortable going out 3-5 years. You could simply work out the free cash for that period and evaluate on that basis, or you could additionally estimate a residual value by simply capitalizing the "final year's" free cash. Because you don't go out as far, you essentially penalize the "tech" stock relative to a branded consumer products company.
So an enterprising investor might combine their methods by, for example, picking three A companies that appear attractive based on the numbers, and four B companies that likewise represent good value a the time of the purchase. Or four and two, or...whatevah, you get the idea.
One thing which bears mention is the effect of taxes. Buffett and Fisher have a huge advantage in that they hold for truly extended periods. If one is purchasing even a "B" company in a taxable account, they should work out how much better that stock must do simply to match the A companies in the portfolio.
Sorry if this question is too open-ended, but hell, if we can't discuss it here where can we discuss it?
I think that it is a most excellent question, and that an open ended question can be about the most valuable contribution anybody can make.
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