Omaha Notes and The Right Amount of Research

What the Berkshire Hathaway weekend might look like post-Buffett and how to balance research depth with taking action

Happy Mother’s Day to all the moms out there. Thank you for all that you do.

Omaha Notes

I was in Omaha last weekend for the Berkshire Hathaway annual meeting alongside 40,000 of my closest friends.

One of the best parts of this trip was meeting some Flyover Stocks readers at Mister Toad on Friday night. We had beautiful weather - not always a sure thing in Omaha in May - and had some great conversations. I look forward to future in-person gatherings with this thoughtful community of investors.

Thanks to Gunnar for thinking to take a picture!

The best part of the Berkshire weekend is meeting up with old friends and making new ones from around the world. You never know who you’re going to run into at a coffee shop, standing in line in the pre-dawn hours, or at the airport. People are ready to share what they do, what they’re working on, and what they’re reading. There’s nothing like it in the investing world and I always come back more energized despite the lack of sleep from the weekend.

The big news from last Saturday was of course Warren Buffett announcing he is stepping down from the CEO role at Berkshire Hathaway and handing the reins to vice chairman Greg Abel. After a 3 AM wakeup to get in line, I was tempted to leave the meeting early and grab a coffee, but I’m glad I didn’t and was able to add my applause in person in recognition of a legendary career.

It’s hard to say what the Omaha weekend will look like going forward. My current take is that it will continue to draw both investors and Buffett tourists for another year, but after that it will be more investors and less tourists.

If you’ve been debating making the pilgrimage trip to Omaha, I encourage you to take the plunge. I hope to see you next year.

The right amount of research

Earlier this week, I came across a recent study on individual investor research behavior by Toomas Laarits and Jeffrey Wurgler, professors at the NYU Stern School of Business.

Among their findings:

“The median individual investor spends approximately six minutes on research per trade on traded tickers, mostly just before the trade; the mean spends around half an hour. Individual investors spend the most time reviewing price charts, followed by analyst opinions, and exhibit little interest in traditional risk statistics.” (my emphasis)

This reminded me of a Peter Lynch quote:

“The public's careful when they buy a house, when they buy a refrigerator, when they buy a car. They'll work hours to save a hundred dollars on a roundtrip air ticket. Yet they'll put $5,000 or $10,000 on some zany idea they heard on the bus. That's gambling. That's not investing. That's not research. That's just total speculation."

I’m not surprised that individual investors as a group do not spend sufficient time researching stocks before buying them, but a median of six minutes was less than expected. To be fair, the average of 30 minutes suggests that there’s a select cohort of serious individual investors doing adequate research.

This is consistent with my experience working with individual investors over the years, but frankly I wouldn’t be surprised if professional investors tracked similarly. Maybe the median is something like thirty minutes and the average is two hours, but I would expect a similar distribution, just further out on the x-axis.

Behind this dynamic is striking a balance between research and action.

At one extreme, you have risk-seeking investors who are primed to take action on little research. At the other, you have risk averse investors that avoid making a decision and rationalize it by saying their research isn’t complete.

Neither group stands to do well over time.

One way to think about the right amount of research is to break research into stages and combine that with a position sizing strategy. Here’s a rough sketch of what that might look like.

• Starter (60% of a full idea): Your pattern recognition skills suggest that this is a high quality business. You’ve done enough research to have some confidence that it has an economic moat and you can identify its moat sources. It’s a business that appears to be understandable, you’re interested in learning more about it, and there’s something about the current valuation that’s compelling. That said, there remain considerable “unknown unknowns.”

• Research (80% of a full idea): After doing more research, you better understand its industry, its competitors, and the problems the company is solving for its customers. You’ve read the last ten years of annual reports and transcripts. You have built a more detailed forecast for the business and have a more comprehensive understanding of the valuation. You can listen to every earnings call and understand all of the metrics and jargon that management and the analysis are discussing.

• Core (90%-100% of a full idea): You’ve followed the company for a number of years, benefitting from the “Look at Your Fish” principle. You understand appreciate the nuances of the business, as well as the company’s corporate culture, to the point where you are confident in how the company would respond to various challenges. You understand the bear case on the company at least as well as the most well-informed short-sellers and you’d be confident appearing on a live CNBC debate with a bear on the stock. Your forecast does not rely on any consensus opinions and is well supported by your research.

Understanding where you are in the research process - Starter, Research, or Core stage - you now have an idea of how much you should reasonably allocate to each holding.

Photo by Lavi Perchik on Unsplash

For example, you might say Starter positions get no more than a 2% weight, Research positions 6%, and Core positions 10%. So even if you fall head over heels in love with a brand new idea, you can only invest up to 2% of the portfolio in that company. This strategy behaviorally permits you to take an action, but limits the risk that one of the “unknown unknowns” ends up being material and impairs your entire portfolio.

As you get more comfortable with the Starter position, you graduate it up to a Research position and can add more capital if the price is still attractive. The same goes for Research to Core positions.

Following this approach, on a valuation neutral basis, your largest positions are those in which you’ve done the most work.

You can read more of my thoughts on position sizing here.

In the coming weeks, I’ll share more watchlist ideas and commentary. For paid subscribers, there will be a new company profile later in the month and profiled company updates.

Stay patient, stay focused.

Todd

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Todd Wenning is the founder of KNA Capital Management, LLC, an Ohio-registered investment advisor that manages a concentrated equity strategy and provides other investment-related services.

At the time of publication, Todd, his immediate family, KNA Capital Management, LLC and/or its clients owned shares of Berkshire Hathaway

Please see important disclaimers.