On Concentration, Patience, and Extreme Wealth Creation

As a family we’ve only sold very limited amounts of Wal-Mart stock…
I think that has really set us apart, and, as I said, that’s the source of our net worth. We just kept that stock.

- Sam Walton in 1992 [1]

Diversification is an animal unique to investing.

It’s sold as an antidote to the risks of investing, a salve to help us sleep well at night. But we don’t see diversification in other parts of our lives. How many of us married 500 people to offset the risk of the relationships not working out? Or worked 20 different jobs in case you got fired from a few? Are we advised to buy 10 different homes in case a few depreciate in value? Quite the contrary: for most American homeowners, their one home makes up the vast majority of their net worth. It would be reasonable to assume that with 500 spouses (do not try this at home!), your relationship with each one would be of far less significance than if you committed to one, and you would likely do better work with one job than 20. Yet, for decades, diversification has been the investing norm. Mutual funds, for example, have continued to own an average of over 100 holdings each.2 To us, financial diversification just does not make sense.

In every other area of our lives, we are perfectly comfortable with extreme concentration. That thinking seems to stop for nearly all when it comes to investing, with a few exceptions. Take the Waltons. When Walmart went public on October 1, 1970, the Waltons owned 61% of Walmart. Their shares were worth $20 million by December 1970. Through the ups and downs in the markets over the ensuing years, the Waltons continued to hold their structurally cost-advantaged, customer-focused business. More than fifty years and three generations later, the Waltons still hold 47% of the company and their shares are worth nearly $200 billion, making them the wealthiest family in the world.3

The Waltons are not unique in this—whether it is the Waltons with Walmart, Bezos with Amazon, Golisano with Paychex, nearly every individual and family with extreme wealth got there the same way— by owning a great business for a very long time. They certainly did not build multigenerational wealth by diversifying. Despite the advice we are sure they had often received, contrary to convention, they focused. With focus and relentlessly becoming better within their niche (you can’t be all things to all people), the results were extraordinary. As we will see, and as the math shows, owning a few exceptional, competitively advantaged businesses over decades is all you need.

First and foremost, concentration only works if you own great businesses. Great ideas are rare, and great multi-decade ideas are even rarer. Between 1926 and 2019, half of all shareholder wealth creation was attributable to only 83 companies out of more than 26,000 publicly listed companies—0.32% of the total.4 The number of businesses that are worth owning are few and far between. With a few great, heavily researched and supported, historically contextualized companies, the math of concentration crystallizes, enabling astounding multi-decade returns: the 69,000x for the Waltons of Walmart, the 1,700x for Bezos of Amazon, and 1,100x for Golisano of Paychex.5 In investing, only a handful of decisions matter. Warren Buffett, with a track record of 58 years at Berkshire Hathaway, noted that their exceptional results (a near 28,000x)6 were the “product of about a dozen truly good decisions—that would be about one every five years.”7

The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders.

- Warren Buffett in 2022 [8]

An important part of the flowers blooming, and the resulting extreme wealth creation, is patience and not cutting your flowers (letting them run) to water the weeds.

So, let’s explore the math of concentration. In Charlie Munger’s words:

“It would not be too much to say it was obvious to me that I could not have a big edge over everybody else and all securities. In other words, it was also obvious to me that if I worked at it, I would find a few things in which I had an unusual degree of competence. It was natural for me to think in terms of opportunity costs. So once I owned three securities—A, B, and C—I wasn’t going to buy any other security. I had actually studied them. I don’t know how much diversification would be necessary over a long period of time. I worked it out with pencil and paper as a matter of probabilities. If you are going to operate for 30 years and only own 3 securities but you had an expectancy of outperforming averages of say 4 points a year or something like that on each of those 3 securities, how much of a chance are you taking when you get a wildly worse result on the average. I’d work that out mathematically and assuming you’d stay for 30 years you’d have a more volatile record but the long-term expectancy was—in terms of disaster prevention— plenty good enough for 3 securities. I had worked that out in my own head using just high school algebra.”

Let’s use Charlie’s three-stock example (diversified by Sam Walton’s standards!) and assume each company was competitively advantaged and growing. The portfolio is equal-weighted from day one. The companies are fundamentally strong businesses, not early biotech bets or commodity-dependent enterprises. Over some stretches the companies would be up, over others they would be down, but on average, let’s assume they’ll outperform the market’s 10% average annual return by 4% a year (far below Home Depot, Intuit, etc.). Over 30 years, Charlie’s timeframe, if the companies follow expectations perfectly, that 14% CAGR results in a 51x versus a 17x for a 10% return (in line with historic market returns)—a pattern that more than 150 US-listed companies have followed.9

Life happens, not all companies are made the same, and there is always a risk of losing money. Assuming a 1/3 chance of a permanent loss of capital over 30 years, we’d still be left with a 34x and a 12% CAGR on the portfolio—comfortably above historic market returns by 2% a year.

What would it take to produce less than the historic 10% annualized return? We’d need to assume a 2/3 chance of a permanent loss of capital (!)—a very aggressive assumption for very competitively advantaged, growing businesses bought at a fair (or even a bit above-fair) price. Even at a 2/3 chance of permanent loss of capital, the expected outcome is still 17x and 9.9% CAGR—a 10 basis point annualized underperformance versus historic returns and far from a disaster. In other words, you could be completely wrong on two of the three companies and still essentially match the historical market return, 10% annualized return for decades (17x over 30 years), by being right about one stock that compounded 4% above the long-term previous averages.

Costco, Walmart, Amazon, Paychex, all 100x+ companies, experienced significant drawdowns over multiyear periods. Amazon was down 80% over a three-year period, Costco down 40% over a five-year period, Walmart down 30% over a seven-year period, and Paychex down 40% over a ten-year period! (See Owner’s Manual.) Mr. Market made it clear—sell Amazon, sell Costco, sell Walmart, sell Paychex. Yet over the fullness of time, that same Mr. Market recognized the enduring competitive advantage of those trackable businesses. Those same companies with extended, multiyear drawdowns have returned 430x+, 69,500x+, 1,700x+, and 1,100x+, compounding at high teens to 30%+ for decades. And a portfolio of them (collectively, just a few rarefied companies) were smoother and produced astounding returns. (Also in the Owner’s Manual.)10

That’s the simple math of concentration at a portfolio level. Now let’s go up 30,000 feet and look at it from an allocator’s perspective.

Even in a diversified allocator’s portfolio, the asymmetry of compounding a concentrated portfolio of knowable, trackable businesses over a multi-decade period still holds. A typical 70/30 portfolio has historically returned approximately 7% annualized for the past 30 years.11

If the allocator invested 3% in a manager they believed would compound at 14% over 30 years by owning durable, growing businesses, their portfolio would return 8.9x, translating to 17% more than the 7% benchmark return. In the case of the highly unlikely event of a complete permanent loss of capital with the 3% weighted manager who owns fundamentally strong, competitively advantaged businesses, the allocator’s portfolio would return 7.4x, 3% less than the 7.6x benchmark return.

This risk-return framework results in a 6:1 asymmetry of returns.

To us, great ideas are rare, and the math of concentration is clear— owning a handful of strong, growing businesses is a logical path to exceptional returns for the patient and aligned.

We all know about the magic of compounding over decades, in investing and in life. We don’t diversify any other parts of our lives, why start it in investing?

Footnotes

  1.  “Made in America” by Sam Walton (1992)

  2.  Lazard, Morningstar, as of December 2014.

  3.  Walmart 2022 proxy statement, Bloomberg, https://finance.yahoo.com/news/top-10-richest-families-world-130024117.html

  4.  Bessembinder (2020), “Wealth Creation in the U.S. Public Stock Markets 1926 to 2019”

  5.  Source for Amazon and Paychex is Bloomberg. Source for Walmart is Global Financial Data (GFD) as Bloomberg data generally starts in 1980. All data is as of June 30, 2023. Total return data for each company assumes gross dividends were reinvested.

  6.  Source: Global Financial Data. As of June 30, 2023.

  7.  2022 Berkshire Hathaway annual letter.

  8.  2022 Berkshire Hathaway annual letter.

  9.  Worldly Partners analysis, Bloomberg. More than 150 US-listed companies have compounded their price per share with dividends reinvested at 14% or more over any 30 year or more time period since trading data on Bloomberg is available (predominately 1980, with the exception of Walmart, which goes back to 1972 on Bloomberg).

  10.  Source for Amazon and Paychex is Bloomberg. Source for Costco and Walmart is Global Financial Data (GFD) as Bloomberg data generally starts in 1980. All data is as of June 30, 2023. Total return data for each company assumes gross dividends were reinvested.

  11.  Using MSCI ACWI and Bloomberg Barclays US Aggregate Bond Index. No other 30-year data available. The National Association of College and University Business Officers (NACUBO) reports a 25-year average annualized return of 6.9% for its 678 participating endowments. Cambridge Associates reports a median 20-year average annualized return of 7.1% for its 231 participating endowments.

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