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May 26, 2006 4:08 pm

Arne Alsin: America’s best investors don’t need Wall Street

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There’s a lot to learn from America’s greatest investors. The great investors that I am referring to are not mutual fund managers or hedge fund managers. They are not gurus from Wall Street who opine regularly on the next hot investment strategy.

It is rare that you will see any of America’s greatest investors on CNBC. And if you do, you will never hear them tell investors which stock to buy. They don’t predict the direction of the economy. They don’t tell you which way interest rates will go.

Who are America’s greatest investors? And what can we learn from them?

For purposes of this article, at least, the greatest investors are those who have generated the greatest amount of wealth from owning stock. They are on the lists of the richest people in America: Bill Gates, Paul Allen, Warren Buffett, Michael Dell, and various descendants of Sam Walton. They made their wealth by ownership of a single stock – shares in Microsoft, Berkshire Hathaway, Dell, and Wal-Mart. (As of this writing, we own shares in Microsoft, Berkshire and Wal-Mart).

Other than Warren Buffett and perhaps Bill Gates, the investors above would probably say they don’t have the skills necessary to write a book on investing. Nonetheless, there are lessons to be gleaned from these great investors about how to build wealth. The good news is these principles are useful to all investors, wealthy or not.

Hold for the long term: each of the named investors generated great wealth by holding on to their shares for the very long term. There are many reasons investors should consider copying their strategy. Taxes and commissions are an obvious reason. Owning a company that is growing by 10 per cent a year and never selling is the rough equivalent – after taxes and commissions – of making 15 per cent a year by frequently buying and selling. Another reason to hold is based on what I call the “jungle mission principle”. Go on enough reconnaissance missions in the jungle and you will get picked off eventually. As an investor, if you switch stocks frequently you will eventually make a mistake. You will get hurt, perhaps seriously. If you’re lucky enough to find and buy a great franchise early in the game, like the greatest investors, hold fast.

Concentrate your capital: most investors are significantly over-diversified, something that is virtually a given if they own a mutual fund. That is because the average equity mutual fund, which owns more than 150 stocks, is over-diversified. Some investors own not one but several of these over-diversified mutual funds. It is highly unlikely an investor can exceed overall market returns – that they can “beat the market” – unless they concentrate their capital. That does not mean investors should concentrate their capital in a single stock, like the investors above. The degree to which capital is concentrated – whether it is on a bare handful of stocks or a dozen or two – should correlate to conviction. As Marty Whitman, the superb value money manager, once said: “Diversification is a surrogate for ignorance.” In other words, if you don’t know, diversify. In the case of the greatest investors, they had sufficient conviction (because they were insiders) to concentrate their capital in a single stock.

Don’t listen to Wall Street: the purpose of Wall Street is not to make money for you. The purpose of Wall Street is to make money for Wall Street. There’s one sure-fire way for Wall Street to boost profits and that is to get you to “do something”. It doesn’t really matter what you do, just do something. Higher activity begets higher profit for Wall Street. Lower activity begets lower profit for Wall Street. If any of the greatest investors had asked the advisors on Wall Street years ago if they should adjust their portfolio, they would have heard a cacophony of “yes, yes, yes!”.

These greatest investors would have heard any number of reasons why they need to “do something”, for example, they should diversify; the economy was sure to swoon; the dollar would collapse; or interest rates were going higher. The success of the greatest investors shows that sometimes the best strategy is to “do nothing”. The Walton family, for example, has held fast to Wal-Mart stock through wars, recessions, inflation scares, interest rate changes, presidential impeachments, and terrorism.

Buy organic growth: the final lesson from the greatest investors is that they made the vast bulk of their wealth through organic growth. Microsoft, Dell, and Wal-Mart are tremendous organic growth stories. They didn’t grow by acquisition, they grew by building it themselves. Building an asset from scratch is not only cheaper than acquisition, it also allows for more intense quality control. In the case of Berkshire, much of its wealth was made by buying and owning great organic growth companies such as Coca-Cola, Gillette, and Geico.


Arne Alsin is portfolio manager for Alsin Capital and the Turnaround fund

arne@alsincapital.com

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