The Punch Card Investor Philosophy
Deep dive research on leading companies in tech, media, gaming and consumer sectors
When I first started out in investing, I read everything I could on Warren Buffett, Charlie Munger, and the rest of the value investing canon. Of everything, perhaps the one idea that had the biggest impact on my investing philosophy was Buffett’s punch card approach that he often taught to business school graduates:
I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches - representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better.
There is so much profound depth and value to this simple concept. Plenty of studies have shown that investment returns follow the pareto principle, whereby the majority of returns (be it for a portfolio, or the market as a whole) come from a small number of investments. By setting a very high bar for what can go into your portfolio, the punch card approach helps you identify and stay invested in the companies that are likely to be long term outperformers. By extending your time horizon you are forced to shift your focus to understanding what is important; a business’s durability, competitive moats, growth runway and management.
The punch card approach is synonymous with another perhaps lesser known concept of the coffee can portfolio. The coffee can portfolio was first written about in 1984 by Robert Kirby, a then portfolio manager at Capital Group, however it got popularised more recently by Chris Mayer in his highly readable book 100 Baggers: Stocks That Return 100-To-1 and How to Find Them (ignore the tacky title, it is truly an insightful investment book). The idea of a coffee can harks back to the Old West when people would put their valuables in a coffee can and kept it under the mattress. The investing application here is simple. Find the best companies you can and let them sit in your portfolio for many years.
Kirby’s 1984 paper describes an investor in the 1950s who piggybacked on the investment advice given by Kirby. This investor put $5,000 into each stock given a ‘buy’ recommendation by the fund manager, and importantly ignored any recommendations to sell stocks. With each stock bought, the stock certificates would be placed into a coffee can and never sold. When the investor passed away, his wife retrieved all the stock certificates in the coffee can and discovered the results of each individual investment varied widely. Many investments were now significantly loss-making, however, quite a few were worth over $100,000, including one investment in Haloid (now called Xerox) which was worth $800,000 (on a $5,000 initial investment). The individual investor’s portfolio had significantly outperformed the fund manager’s portfolio over the same time period. The main tenet of the punch card or coffee can approach is picking high quality companies, patiently letting your winners run, and not being tempted to trade them due to economic news, macro forecasts, market volatility, or just boredom. As per the words of Charlie Munger (quoting Blaise Pascal approvingly): "all of humanity's problems stem from man's inability to sit quietly in a room alone."
Of course finding companies that will be long term outperformers is easier said than done. The majority of companies underperform the market, and very few have the durability or exceptionality to achieve above market returns over a period of over 10 years. It’s even harder having the patience and the emotional wherewithal to hold these stocks over a long period of time, as the market, media, people around you and general external noise will always try to trip you into taking unnecessary actions. To identify the high quality durable companies that will be placed on your punch card and build the conviction to hold them for the long term, I believe you need to develop a deep understanding of their business, competitive advantages and risks. In this blog I will be doing deep dive research pieces into specific companies that I find interesting and may be compelling long term investments.
There are three key ingredients that I believe are essential for identifying punch card investments:
The business needs to either have sustainable competitive advantages or moats that allow it to fend off competition and generate high returns on capital, or is on the path to establishing them
There needs to be a long runway for growth and opportunities for the company to keep reinvesting its capital at high rates of return
There needs to be a high quality management team with excellent execution and capital allocation capabilities. Ideally the business is founder-led but doesn’t necessarily need to be. What is important is proper alignment of interest, integrity, accountability, and adaptability/willingness to learn (something that is important if a business is to survive a long time in a fast-changing dynamic world)
I believe businesses that have the above ingredients can come from a range of industries, stages of lifecycle and style factors. I don’t think of myself as either a value investor or a growth investor in the traditional definition of these terms. I think such labels are extremely limiting and can close your mind off to opportunities. I think of myself as a collector of great businesses. Value can be found in many forms. I am equally comfortable holding high growth, high priced tech darlings like Sea Limited as I am the bastion of value stocks such as Berkshire Hathaway, as both are great businesses that have different strengths and merits and can deliver sustainably high returns for my portfolio over a long period of time. Being able to hold an eclectic mix of assets like this and not being pigeon holed into a style is also one of the key advantages that individual investors have over professionals.
On selling, I don’t completely subscribe to the “never sell” idea, as fundamentals do change over time and your original investment thesis can get broken. Capitalism is after all a force of creative destruction. As such I believe it is important to follow the companies that you own and watch for potential impairment. However I would lean much closer to the idea (or at least the aspiration) of never selling than the alternative such as selling whenever the stocks have hit some arbitrary price targets or there is sector rotation going on or other reasons. If anything I will just continue to add to these companies particularly when the market goes through its regular bouts of turbulence. Despite all of the so-called Buffett acolyte value investors amongst the professional community, a lot of fund managers have a bias for action. They feel like there is a need to show their clients that they are doing something, particularly when underperforming, which results in excessively high portfolio turnover. Private individual investors do not face such institutional pressures.
The focus of this blog will be on deep dive research pieces on specific companies. My sector interests and experience is largely in technology, media, gaming and consumer sectors, but I am looking to expand my circle of competence gradually. My deep dives will essentially be standalone investment papers comprising of in-depth analysis of the companies and their value proposition, the investment thesis, valuation and return projections, and risks / bear case arguments. My objectives with the blog are to help me formalise my thinking on these companies, share ideas and insights and receive feedback. Above all else, I am dedicated to learning. Over time I will also look to expand this space to share my thoughts on broader investment topics as well as book summaries / reviews across a variety of subjects that I read including business, psychology and history.
Companies covered: Etsy, Take-Two, Sea Limited, Zebra Technologies, Nvidia, LVMH, AMD
Thank you for dropping by, and please feel free to reach out anytime via the comments below or Twitter @punchycapital