Ben Graham's 200x Microcap Gamble: The Surprising Secret Behind this Buffett Mentor's Investment Success
Ben Graham's 200x Microcap Gamble: The Surprising Secret Behind this Buffett Mentor's Investment Success
“One lucky break, or one supremely shrewd decision – can we tell them apart? – may count for more than a lifetime of journeyman efforts.”
-Benjamin Graham
Recently, I found myself thumbing through my copy of the investment classic The Intelligent Investor.
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Published in 1949, The Intelligent Investor established Benjamin Graham as the father of value investing.
Warren Buffett called it “by far the best book on investing ever written.”
My notes in the margins confirmed that I had read the book carefully decades ago.
But as with many classics, each time you read it, you get more out of it.
The same applies here.
That’s because, until this week, I had never read the postscript.
And what I read changed the way I thought about value investing.
In the postscript, Graham tells the story of two partners of an investment firm…
[They] combined good profit possibilities with sound values. They avoided anything that appeared overpriced and were rather too quick to dispose of issues that had advanced to levels they deemed no longer attractive. Their portfolio was always well diversified, with more than a hundred different issues represented. In this way, they did quite well through many years of ups and downs in the general market; they averaged about 20% per annum on the several millions of capital they had accepted for management, and their clients were well pleased with the results.
In short, these were conservative, well-diversified value investors.
Ben Breaks the Rules
Then, one day in 1948, Graham and his partners broke all their rules.
They came across an opportunity to purchase around 50% of a growing business.
They were so impressed by the opportunity that they invested about 25% of their fund’s assets into this single stock.
Graham wrote this was "a highly unusual departure for the conservative managers, who normally diversified widely and seldom invested more than 5% or so in any one holding.”
It also turned out to be the most profitable decision they ever made.
The stock – Geico – had gone up more than 200-fold. (Since 1996, Geico has been a subsidiary of Berkshire Hathaway.)
Nor did the usually conservative partners sell it when the stock reached fair value.
“Ironically enough,” Graham wrote…
The aggregate of profits accruing from this single investment decision far exceeded the sum of all the others realized through 20 years of wide-ranging operations in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions.
Then came the big reveal.
One of the partners in this firm was Graham himself.
Three Big Takeaways
After I thought about it, three things stuck out to me.
First, there was Graham’s conclusion: “One lucky break, or one supremely shrewd decision – can we tell them apart? – may count for more than a lifetime of journeyman efforts.”
Investing is a game of probabilities. Uncertainty dominates investing. And dumb luck plays a far more critical part in separating winners from losers than we care to acknowledge.
And in that way, investing is a terrific metaphor for life.
Second, it confirmed that a small number of winners in an investment portfolio account for the bulk of your gains.
And you don’t need many such winners. Graham needed only one.
The same applies to Graham's disciples, Buffett, and Berkshire Hathaway.
As Berkshire Vice Chairman Charlie Munger said in a speech at USC Business School in 1994…
You don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top 10 insights account for most of it. And that’s with a very brilliant man – Warren’s a lot more able than I am and very disciplined – devoting his lifetime to it. I don’t mean to say that he’s only had 10 insights. I’m just saying that most of the money came from 10 insights… You’re probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It’s just that simple.
Third, how can you apply this insight to your own investing?
The process is straightforward enough.
Research diligently to assemble a portfolio of Geico-like high-quality businesses with high growth potential at a reasonable price.
Note that this portfolio won’t include Apple, Amazon, or any other blue chip stock or household name.
Megacap stocks, by definition, cannot be tomorrow’s 200x winners like Geico.
Instead, the portfolio will be comprised of microcap stocks with a massive “moonshot” potential.
Stick with these picks over time as long as the underlying businesses do well.
And add to your positions when “Mr. Market’s Moodswings" offers to sell you more stock at a low price.
Rinse and repeat.
As for Graham, most of your returns will come from just a handful of stocks.
The Pareto principle teaches that 80 of your gains will come from just 20% of your stocks.
Taken a step further, 96% of your gains will come from just four stocks.
That’s OK
Remember, you only must pick one or two Geicos in your investment lifetime to generate massive returns.
May good fortune smile upon you.
P.S. I am launching a new investment advisory service that focuses just on identifying such Geico-like microcap opportunities.
I call it “Microcap Moonshot Millionaire.”
Watch for more information on this project in the coming days.
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