Is diversification for idiots?


Concentration is cool

Value investors are prone to make outsized bets on single stocks or have extremely concentrated portfolios.

Mark Cuban has a more blunt view of diversification:

“Diversification is for idiots.”

Warren Buffett, the master himself, made many concentrated bets throughout his investing career. The most famous example is American Express during his partnership days. After the salad oil scandal in the 1960s, American Express stock plunged. Most investors thought the salad oil scandal would put American Express out of business and the stock fell.

Buffett realized that American Express would survive and knew it was a fantastic franchise. He moved an astonishing 40% of the partnership’s assets into American Express, sending the partnership’s returns from great to extraordinary. Buffett would repeatedly make concentrated bets throughout his career when he had conviction. He took on significant, concentrated positions in companies like GEICO and Coca Cola.

Buffett had this to say about diversification:

“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”

Munger has this to say:

“The whole idea of diversification when you’re looking for excellence is totally ridiculous. It doesn’t work. It gives you an impossible task.”

Because value investing has come to mean whatever Warren Buffett and Charlie Munger say it is supposed to mean, most value investors take their advice to heart and make big, courageous, outsize bets on their “best” ideas.

The Other Side of Concentration

Concentration is cool until it is not. Legends like Bill Ackman built up early, stunning returns by concentrating on their absolute best ideas. This worked well until Ackman’s best ideas were Valeant and shorting Herbalife.

Concentration worked out well for Joel Greenblatt, whose early hedge fund used extremely concentrated portfolios of spin offs and special situations to deliver stunning returns.

Ben Graham recommended holding 30 stocks and believed this would provide adequate diversification. The eggheads in academia actually agree with him on this point, and most the research shows that an ideal portfolio is around 20-30 stocks.

Other successful value investors who are more in the Graham state of mind also have diversified portfolios. Walter Schloss owned over 100 stocks. Seth Klarman currently has 35 holdings. Irving Kahn also stuck to Graham’s advice and owned 20-30 positions at any given time.

The Evidence

For me, I’m more interested in the evidence of what works so I conducted backtests on a value portfolio in an effort to identify the ideal number of holdings. I backtested the returns and characteristics on a simple EV/EBIT portfolio. I began with the insane portfolio of buying the single cheapest stock in the S&P 1500. I then added the next cheapest, creating portfolios ranging from 1 stock to 30 to determine the ideal size.

This is pulled from an S&P 1500 universe, the backtests are conducted since 2005, and the portfolios are rebalanced annually.


The return characteristics of different portfolio sizes are all over the place, but they all beat the market over the long run. Strangely, they start out high, bottom out around a dozen stocks, and then start to improve.



I don’t think volatility is risk. I believe risk is the probability of losing money permanently. However, I also believe that volatility accurately measures how big a container of Tums that you should have at your desk.

I also don’t think a Sharpe ratio is the accurate representation of how decent a portfolio is.

With that said, here are the results:



In terms of volatility, most of the benefits come from the first dozen positions. However, in the context of EV/EBIT, the Sharpe ratio tends to max out around 25 positions.

Maximum Drawdown

My view of risk is less about volatility and more preventing blowups that will permanently impair my capital.

The bigger the blowup, the harder it will be to recover from it. In mathematical terms, large drawdowns are increasingly more difficult to recover from.


The deeper the drawdown, the bigger that the bounceback needs to be. Once the drawdown exceeds 50%, it becomes nearly impossible to recover from. Drawdowns of the 80% magnitude are almost certainly fatal to investment results. Common sense tells us that concentration will lead to years where returns are remarkable and that this will likely be balanced out by deep and painful drawdowns later on. The evidence backs this up.


Concentrated portfolios are prone to some genuinely epic drawdowns. For the insane 1-stock portfolio, the maximum drawdown was 90%. Over the long run, the 1-stock cheap portfolio delivers a return similar to all of the others, but you will likely jump out of a window or develop a drug problem before you can actually enjoy those returns.

It appears that the first 15 positions can at least get the portfolio down to the market’s maximum drawdown.


  • Most EV/EBIT portfolio sizes beat the market, from the ultra-concentrated to 30 or more stocks.
  • In terms of reducing volatility, the first dozen stocks provide most of the benefits of diversification.
  • It takes at least 15 stocks to reduce the odds of a portfolio blowup that will exceed the maximum drawdown of the S&P 500.
  • Sharpe ratios tend to be maximized in a value portfolio around 25 positions.
  • Diversification is not for idiots.
  • Ben Graham was right (as usual), and the ideal portfolio size is somewhere around 20-30 positions.


“Killing Eve” is a great show.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

CD’s & Cash


After the run-up in the market, there are no longer a lot of bargains.

I also think a recession is coming in the next couple of years, so I don’t want to take on unnecessary risk and would like to gradually unwind. I want to have plenty of cash to take advantage of the next downturn.

Additionally, looking at some of the mistakes in my portfolio, I noticed that they all happened when I bought subpar stocks just to stay 100% fully invested. Looking back on it, I would have been better off if I only purchased the bargains I felt were compelling, as I did with the stocks purchased in December 2018. I would have been better off if I held more cash and only bought when I had more conviction.

Thinking about all of this, I turned to the writings of Seth Klarman for advice. I think he nailed it with these quotes about this topic:

“Our willingness to hold cash at times when great opportunities are scarce allows us to take advantage of opportunity amidst the turmoil that could handcuff a competitor who is always fully invested.”

“It wouldn’t be overstating the case to say that investors face a crisis of low returns: less than they want or expect, and less than many of them need. Investors must choose between two alternatives. One is to hold stocks and bonds at the historically high prices that prevail in today’s markets, locking in what would traditionally have been sub-par returns. If prices never drop, causing returns to revert to more normal levels, this will have been the right decision. However, if prices decline, raising prospective returns on securities, investors will experience potentially substantial mark to market losses, thereby faring considerably worse than if they had been more patient.”

So, I moved $1,992.16 into short-term CD’s that mature in December with a 2%+ yield to maturity. The mid-December maturity coincides with my standard portfolio rebalance. Hopefully, at that point, more bargains will be available.

I considered moving towards a long-term bond ETF, but that is an outright speculative bet that a recession will happen. I think a recession is a likely outcome in the next 1-2 years, but I do not think I should make an outright speculative bet on that outcome.

For now, I will stick to the traditional value investing strategy. When I can’t find a new bargain, I will hold cash and cash instruments like CD’s and short term bonds. I will resist the impulse to stay fully invested at all times.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Hooker Furniture (HOFT)


Key Statistics

Enterprise Value = $358.61 million

Operating Income = $49.48 million

EV/Operating Income = 7.24x

Price/Revenue = .53x

Earnings Yield = 10%

Debt/Equity = 15%

The Company

Hooker Furniture is a Virginia-based furniture company that has been in business since 1924. They own multiple brands. Their line of Hooker branded furniture includes items for home entertainment, home office, accent, dining, and bedroom. They also own an upholstery segment and acquired the Home Meridian brand in 2016.

Hooker primarilly sells their furniture to other retailers without the burden of a massive physical brick and mortar footprint. They sell their furniture primarily to independent furniture stores, department stores, warehouse clubs, and e-commerce retailers. Their furniture is featured prominently on Wayfair, for instance.

The stock has been punished since last fall due mainly due to macro moves in the broader market that aren’t showing up in the actual operating results of the company.

My Take

Hooker Furniture is a business with a bright long term future. I really like the fact that they don’t have a big physical brick and mortar footprint. This keeps them versatile as brick-and-mortar stores face pressure due to mounting threats from e-commerce. As furniture demand dries up in the stores, they should be able to quickly replace that demand with more sales to online businesses.

Hooker Furniture also has a solid long term track record. They never suffered a loss during the Great Recession, and have grown steadily through every year of the expansion. Their acquisition of Home Meridian is a smart move and was completed while maintaining a conservative balance sheet. The company earned $2.42/share last year, which compares to a $.80/share 5 years ago.

The risk is that this is a cyclical business. The yield curve just inverted and we are likely to have a recession in the next two years if past history is any guide. Despite this risk, when I saw this company show up in a few of my stock screens, I couldn’t resist it when I did more research. At current multiples, it’s too compelling of a bargain to pass up. It’s indeed an excellent company at a bargain price.

From a relative valuation standpoint, Hooker’s current P/E of 10.40 compares to a 5-year average of 17. The current P/E is also significantly below the P/E of competitors in the industry, such as Flexsteel, which trades at a P/E of 24. Another competitor would be Basset Furniture, which currently trades at a P/E of 19. An increase in P/E to the 5-year average would be a 63% increase from current levels. A P/E of 15 seems right for a steadily growing, well run, conservatively financed, and versatile company like Hooker furniture.  HOFT also trades at 53% of sales, which compares to an industry average of 72%. On an enterprise multiple basis, Hooker’s current 7.24x multiple compares to a 5-year average of 10.67. An increase to this level would be a 47% increase from current levels.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.


I reduced my exposure to Argan (AGX) today. After the price run-up, the position had grown to about 8% of my portfolio. I sold the block of it I purchased on 3/23/18.

I sold 25 shares @ $50.94 for a 30% gain from the purchase price a year ago.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Q1 2019 Update


I had a good quarter. I gained 15.74%, which compares to the S&P 500’s total return of 13.5%.

For the last few years, I’ve done a major rebalance in December and then usually did absolutely nothing in the first quarter. This year, the market move and company specific events compelled me to sell some positions, and with the cash I established some new ones.


Gamestop – After two years of waiting in Gamestop for the company to be bought out,  Gamestop announced they were going to stop trying to sell to a private equity firm, dashing all of my hopes. The major source of Gamestop’s cash flow is the re-selling of old video games and system platforms. This is a dying business as more video game consumers will download games directly and purchase platforms online. With that said, I think the business will be around longer than the market thinks. This is why about 4 years of Gamestop’s business could pay for the entire company. While the business is  in decline, this cashflow has value if Gamestop plays it correctly. My hope was that an acquirer would see this value, because Gamestop itself seems to be blowing the dwindling cash on dividends.

Looking back at this debacle, I likely should have sold this after the first accounting loss a year ago and admitted defeat. I also foolishly doubled down on the position in 2017. This is usually a bad idea. I lost 52% on the stock.

Sanderson Farms – I sold Sanderson Farms after an operating loss. At the moment, this looks like a mistake. The stock is now up to $130/share from my sale price of $115/share. Sanderson is a great company, but I try to sell when my positions approach a rich valuation, even if I like the business. A higher valuation plus a top line loss compelled me to sell. I made 16.6% on the position. I will likely return if the stock becomes cheap again.

ProPetro – I made 45.33% on this position in a very short time. I purchased this in December, and I thought the uptick was absurd, so I sold. Since then, it has gone higher.

Gap – Gap announced on March 1st that they were going to split the company up into a “good company” (Old Navy) and a “bad company” (all of the mall retailers). The stock soared on the news very quickly in one day. This made no sense to me, as current shareholders still own the same thing. I thought the increase didn’t make any sense, so I sold for a 19.76% gain. This looks like it was a good trade, as I sold at the top after the surge and the stock has steadily declined since then.

Thor – Thor reported terrible results and I sold the stock because of the deteriorating fundamentals. I sold the stock for a loss of 38.27%.

Aaron’s – Aaron’s reached a 52-week high in March, and the valuation increased significantly, so I sold the stock for a 29% gain.


With all of the unexpected cash from my sells, I purchased some brand new positions. The new positions are listed below with links to my rationales.

  1. Louisana Pacific
  2. Hollyfrontier
  3. Winnebago
  4. Urban Outfitters
  5. Express

I also expanded my position in Nucor.

The Value Opportunity

In the fall of last year, Mr. Market’s temper tantrum created a high number of bargain stocks, which is historically an excellent sign for value stocks. More bargains typically result in higher returns.

In December, the number of cheap stocks in the Russell 3,000 peaked at 108 stocks. My definition of cheap is an EV/EBIT multiple under 5.

The below chart, which I put together back in 2017, breaks down the number of cheap stocks in the market and the subsequent return they delivered over the next calendar year.

Generally speaking, a higher quantity of cheap stocks tends to result in higher returns for this group. It means that the “cheap” stocks are unusually cheap, giving them a long runway to expand their multiples and substantially increase in price.


2000 and 2001 stand out as years of substantial outperformance for value. The indexes suffered declines as the tech bubble deflated, but value performed exceptionally well. This is because the cheapest stocks were cheap on an absolute basis after being overlooked during the mania of the late ’90s and their multiples expanded despite the carnage in the broader market.

I noticed that the situation at the end of 2018 was similar to 2000, a year which delivered epic outperformance for value investors. There were over 100 cheap stocks in the US market and, as the yield curve had not yet inverted, it didn’t seem likely that we were going to have a recession.

The market delivered on this faster than I imagined. December was a time when investors needed to strike while the iron was hot, as the opportunity came and quickly dissipated. As a group, the number of cheap stocks went from 108 on Christmas Eve to 67 today.

The record for this cohort has been mixed. In February, the group was up nearly 20% for the year. That gain has since dissipated to a 10% year to date return, now underperforming the index.  We’ll see how this shakes out as the year continues.


I think that the yield curve is the best indicator of the likelihood of a recession. I covered the use of the yield curve as a recession predictor in this post: the Dark Art of recession prediction.

Why does the yield curve “work” as a recession indicator? Simply put, the Federal Reserve is the dominant factor in the business cycle. The Federal Reserve is the cause of and cure to nearly every recession. Expansions in the US end when the Fed is too tight. A yield curve inversion is a sign that the fed is too tight.

The 3-month and 10-year treasury yield inverted a few weeks ago. The 2 year and 10 year haven’t inverted yet, but have flattened. The 10 and the 30 is another good indicator, as pointed out in this post by Scott Grannis.

There is typically a lag between a yield curve inversion and the onset of a recession of a year or two. There is a similar lag between Fed cuts and the beginning of a new economic expansion. The yield curve inverted in 2005-06 and the impact of that relatively tight monetary policy wasn’t felt until 2008-09. The Fed began aggressively cutting rates in 2007, but this didn’t start to have a positive effect on the economy until late 2009.

Ray Dalio famously says an economy is a machine. I think it’s more likely an organism, responding slowly and organically to policy changes.

The slow way that the economy responds to these changes is difficult to navigate for investors. We are like blindfolded people trying to navigate our way through a funhouse. It’s particularly confusing because the year or two after a yield curve inversion is often one of the best parts of the business cycle. The economy is red hot, and everything seems wonderful. Think about the mood in 1989, 1999, or 2006. The party was about to end, but it was also at its most roaring. All of these years were after a yield curve inversion, and it was difficult for investors to look at the robust economy and imagine how it could fall apart.

Ensemble Capital had a great tweet summarizing how strong the environment is at the end of the cycle.


It’s almost as if the market tries to lure investors in before it slaughters them.

Another great indicator of where we are in the cycle is trending in the unemployment rate, as pointed out in this post. Right now, the unemployment rate hasn’t yet changed its trend, but it looks like it is flattening. It is already below the lows experienced in 2000. How much lower can it go?

uetrendA yield curve inversion is like a yellow light. A shift in the unemployment rate is a big red light telling you that a recession is imminent and we might already be in one.

I still think the yield curve is a valuable tool for forecasting recessions. One of the reasons it is such a useful tool is because so many people doubt it every time it happens. I remember being a teenager watching CNBC in the late ’90s and listening to pundits say that the yield curve didn’t matter. A popular narrative at the time was that the US budget surplus was distorting rates. There was similar talk in 2006. A popular narrative at that time was that the “global savings glut” (emerging markets had high savings rates and they were pouring money into treasuries) was distorting the bond market, and the yield curve didn’t mean anything.

No one wants a recession except for maybe the perma-bear crowd. Listening to a recession prediction is like telling someone that they’re going to get into a car accident tomorrow or that their significant other is going to cheat on them. It’s a horrible prediction, and our minds will try very hard to find reasons not to believe it.

The narrative this time is that rates are too low for the yield curve to matter. The Fed can’t trigger a recession when the Fed funds rate is only 2.5%. I don’t accept this explanation, either. I think rates are only “low” in the context of our experiences in the ’80s and ’90s, when rates were abnormally high.

I like to boil things down to their essential components, and I don’t think anything explains the relationship between the quantity of money and inflation better than the classical equation, MV = PQ, the equation of exchange that Milton Friedman had on his license plate. The equation simply states that the quantity of money and the velocity of money are the key determinants of inflation.

The instinct of most people was that the Fed’s dramatic expansion of the money supply would result in a massive inflation problem. This never happened. Inflation hasn’t even gone above 3% throughout this entire expansion.

It seemed logical that an explosion of the Fed’s balance sheet and the quantity of money would result in massive inflation. The reason this didn’t happen is that the velocity of money remained stuck at an absurdly low level after the carnage of the financial crisis.

This decline in the velocity of money could have happened for a few reasons. It could be demographic reasons, such as declining birth rates and an expanding elderly population. This is a popular explanation for what happened in Japan, who didn’t experience inflation after an explosion in their own monetary base and ultra-low interest rates. The US has more favorable demographics than Japan, so I’m not sure if this holds up. Another possibility is that the crisis was so severe that it psychologically scarred households and firms and depressed the overall velocity of money.

Whatever the explanation, it looks like monetary velocity is stuck at a low level, meaning that rates can stay “low” with little impact on inflation.


Money velocity: extraordinarily low


Inflation: can barely crack 3% even with unemployment near all-time lows

Rates look low when we compare them to recent experiences in the ’80s and ’90s, when we were working off the Great Inflation of the 1970s and when money velocity was high. I believe that with an inflation rate below 3% and money velocity stuck at a low level, a 2.5% fed funds rate can be high enough to push the economy into a recession even though it appears to be absurdly low based on our experiences in recent decades.

What do I do about it?

The phrase “late cycle” has become a punchline. People have been saying “late cycle” for the last 7 years. With that said, the yield curve seems to indicate that at this point we really are in the late cycle. This is 1998, 1989, 2005. Trouble is probably on the horizon.

In my little world, I am merely trying to determine what I should do about it.

Option #1 – Do nothing and stay fully invested. This is what Peter Lynch and Warren Buffett would recommend. They ignore the macro environment and focus on the businesses in the portfolio. This would also be the advice of many quants, who all advise that timing the market is nearly impossible. I’m sympathetic to this point of view, but I find it hard to accept. I analyze individual businesses, but none of them exist in a vacuum. Their fates are wholly determined by the macro environment, so I find it hard to accept the idea that I should just ignore it completely. It also doesn’t jive with what Munger and Buffett actually do. Berkshire carries massive cash balances. Munger kept Daily Journal mostly out of the market in the mid-2000s, moving aggressively once the global financial crisis dished out a tremendous opportunity set.

Option #2 – Get out of stocks completely. Should I get out of stocks completely? It is extremely difficult to time an economic cycle correctly and it is even harder to time a factor like value. There are unusual moments such as the early 2000s when value investing performed well even though the economy was in a recession. Missing a time like that would be terrible for my returns.

Much of the evidence indicates that the cycles are so difficult to time and the performances are so lumpy that it’s best to just stay fully invested.

My sense is that this cycle is more like the late ’60s and early ’70s than it is like anything like the ’90s or 2000s. The ’70s was a period of time where value was crushed with the overall market in the ’73-’74 drawdown. The darlings of that era, the Nifty Fifty, weren’t anything like the late ’90s absurdity. They were quality companies at crazy valuations.

How did value hold up during this period? Below is a comparison of S&P 500 returns to those of Walter Schloss along with the low P/E low debt/equity strategy that Ben Graham pursued and was backtested by Wes Gray’s Alpha Architect team.


Schloss was known for holding a lot of cash when he couldn’t find bargains, which is likely why he avoided a lot of the horror in the ’73-’74 drawdown. The fully invested Ben Graham quant strategy fared worse.

I would like to avoid the next drawdown and have a lot of cash to take advantage of the opportunities that will emerge in the aftermath of the decline.

The classical value investing approach is to not time the market but only invest in the bargains, like Schloss did. At the end of the expansion, there will be fewer bargains, and you’ll end up accurately timing the market without really trying.

This approach is easier said than done. If you took a classical asset value approach, Schloss would have had to wind up the partnership in the late ’60s when the net-net’s disappeared in the United States. Instead, he shifted his focus to stocks selling below book value. If he waited for the net-net’s to return, he would have missed out on some of his best years for returns. Not only could you wait for a few years, but you could also end up waiting for an investing lifetime.  For this reason, I think it would be foolish to “get out” of the market entirely.

At the same time, I don’t want to suffer horrific drawdowns and have no cash to take advantage of the opportunities that will inevitably result from a significant drawdown.

Option #3 – Short the market. I don’t short anything. I am proud to say that I have never shorted a stock in my life. After following markets for the last twenty years, I have developed a deep appreciation for how insane markets can be. Tech stocks were overvalued in 1998. They still doubled in 1999. Enron was engaged in fraudulent behavior going all the way back to the 1980s. It didn’t melt down until 2001.

Shorting is speculation and can result in a permanent loss of capital. I don’t do it. Shorting is for masochists.

This isn’t to knock the shorts. They’re the smartest people in the market and often do the most in-depth diligence. This doesn’t make it a wise investing strategy. I feel the same way about marathon runners. They are hard working, dedicated, impressive people. They’re also masochists who pursue pain for the sake of pain. Just because they are awesome individuals doesn’t mean that it’s a good idea to go out and run a bunch of marathons.

I’m also not interested in hedging. The best hedge is to merely own less of whatever it is that you’re hedging.

I’m also averse to complicated investing strategies. Perhaps I read “When Genius Failed” too many times. Whenever I hear a complex investing approach touted by an investing egghead, it’s hard for me not to roll my eyes. My instincts scream at me to steer clear.

Option #4 – Gradually adjust my positioning.

This is what I will probably do.

Right now, the cheapest stocks in the market are cyclicals. I own a lot of them. These stocks will likely be annihilated in a drawdown. Winnebago is a glaring one. There aren’t a lot of people with enough confidence and disposable income to go out and buy a big, expensive, RV during a recession. Winnebago suffered an 80% drawdown during the financial crisis.

Additionally, the fact that a yield curve inversion usually takes a year or two to impact the “real” economy gives me time to adjust my positioning. As I sell positions (as they age, run up in price, or the fundamentals change), I will likely reduce my positioning in cyclicals.

I will probably hold onto my cheap insurance and more defensive picks. Oshkosh is a good example. With a significant chunk of their business originating from the federal government, it should hold up well in a large equity drawdown.

Fortunately, I own zero leveraged companies. I specifically stick to stocks with low debt/equity ratios at all times because I know they will hold up well in a drawdown and I have a healthy enough respect for the market to know that a bloodbath can happen at any time, regardless of what the yield curve and unemployment are doing. It’s also what Ben Graham recommended. I covered my logic for this approach in this post about the debt/equity ratio and how a lack of leverage provides protection during drawdowns. To summarize, sticking to companies with healthy balance sheets enhances long-term returns by reducing the extent of a drawdown during a market meltdown.


As I reduce my exposure to cyclicals, I will need to find a home for the cash. I don’t want this money sitting around earning nothing. I am considering buying more defensive stock picks and accumulating a position in long-term government bonds. As the Fed reduces interest rates to combat a recession, long-term bonds should perform well. Long-term bonds increased by over 20% in 2008, for instance. I will likely do this through an ETF vehicle like TLT.

At the same time, if I’m wrong, long-term bonds will go down but will still pay interest and won’t suffer huge drawdowns. I think this is a much safer choice than outright shorting the market.


I’m curious about your thoughts and input into how you are navigating the rapidly changing environment. What do you think the best approach is?


I love the latest season of Documentary Now. The below is an excellent parody of “Wild, Wild, Country.”



PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.


I am a value investor. My outlook is inspired by the ideas of Benjamin Graham. This site is a real time chronicle of my portfolio and an outlet to share my ideas. I hope you enjoy.