I have read a couple of articles lately which have peeked my interest in this topic again. For those of you who have no idea what I am talking about, let me just give you a quick initiation.
I think Warren Buffett coined the phrase, and this is what he had to say about it. “I always tell students in business school they’d be better off if they were given a card with twenty punches on it. And every time they made an investment decision, they used up one of their punches, because they aren’t going to get 20 great ideas in their lifetime. They’re going to get five or three or seven, and you can get rich off five or three or seven. But what you can’t get rich doing is trying to get one every day.”
What Buffett is essentially saying is that one should make very few investment decisions during your investing life. He is saying that you do not have to try to invest in every stock that looks promising and to churn your portfolio in order to keep chasing the latest promising stock. He is in fact saying that good investments are extremely rare, and that you should wait for these rare opportunities.
I must be honest and say that to use a punch card is an area which I have only recently come to really appreciate and to understand. It is also the hardest part of investing to get right. I am always seeing stocks that I see as attractive and want to invest in. Then as soon as I have the cash, I dive in. On the whole my stock picks have been good and I have been compounding returns at a good rate, but it could have been better. I have written at length about a hotel stock that I am waiting to exit. While this will be profitable, I have had to pass up some other great opportunities. Had I followed the punch card rules, I would not have dared using a punch on the hotel stock, no matter what value I saw, except for perhaps a portion of my portfolio which was dedicated to such value stocks, more on that later though.
I have written before about my desire to own quality businesses. I want to partner with some of the best businesses in the world, wherever they are located, and to join them on their ride to success. Finding these businesses at reasonable valuations is the hard part. We all know some quality businesses, just look in your kitchen or bathroom cupboard and some names of these businesses will be staring back at you. The problem is that everybody else knows they are quality, and thus they are expensive. However, sometimes, rarely, prices of such businesses do not reflect their value, and this is when I will become interested.
Forgetting the punch card rule cost me
So far I think I have done a reasonable job, but allow me to give you an example of where I have slipped up fairly recently. About a year and a half ago I received the proceeds of a house sale. Once all debts were settled I had a reasonable amount left over to invest. The aim was to provide an income for myself, as well as growth. While I believe I made good decisions with 75% of the funds, I was impatient with the last 25%. The quality stocks all looked expensive with P/E ratios above 20. Being impatient I went ahead and invested the 25% in a logistics business which was trading on a P/E ratio of about 7 and a dividend yield of about 6%. While the company is not a bad business at all, and is well run, I have so far lost some money on it. These businesses are cyclical, and with a depressed economy they go down. It should have better days if I am patient enough to wait. The main reason I am annoyed at myself though is that I bought a good business, not a great business. This makes all the difference. This is where the punch card rules would have been useful.
Why a punch card is useful
- Discipline: You are disciplined to only go with your great ideas, not your mediocre ones.
- Research carefully: Not wanting to make a mistake, given your limited number of times you can invest, you will be meticulous in your research to make sure you are not making a mistake.
- Costs reduced: Trading and frictional costs are reduced as under this system you do less trading and more research. Less costs = more capital to invest.
- Tax reduced: Less buying and selling = less tax.
Now, this is the basic version of punch card investing, but I read another article recently related to this topic which I also found very interesting, and relevant to myself. The article touched on the fact that Warren Buffett, while espousing punch card investing, had in reality not practiced it himself. In a future post I will touch on this, and why perhaps some rules can be broken if one is investing intelligently.