Punch Card Investing

Today, I’d like to talk about the concept of punch card investing. This was a concept that was popularized by Warren Buffett.

Mr. Buffett described punch card investing in the following way:

I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches–representing all the investments that you got to make in a lifetime.  And once you’d punched through the card, you couldn’t make any more investments at all.  Under those rules, you’d really think carefully about what you did and you’d be forced to load up on what you’d really thought about.  So you would do so much better.
Warren Buffett

So, punch card investing is only making 20 investment decisions over the course of a lifetime. The idea behind limiting the number of investment decisions that an investor makes is very rational. Financial markets are extremely competitive and you are not likely to find inefficiencies or mispricings very often. So, on the rare occasions when you do find mispricings or inefficiencies, you need to be ready to act in size. You need to be able to buy up a boatload of these investments. And if you’re only going to buy 20 or so investments over the course of your life, you need to know these investment situations very well and have a strong belief that they are going to substantially outperform over time.  (Please note that these 20 punch card investments would be considered active investments.)

These punch card investments need to be like shooting fish in a barrel. On the few occasions when you come across one of these investment opportunities, it needs to be so obvious that it should be purchased, it should be like shooting fish in a barrel. In other words, it should be a no-brainer.

Charlie Munger, Warren Buffett’s partner and Berkshire Hathaway Vice Chairman, had this to say about his success:

I didn’t get to where I am by going after mediocre opportunities.
Charlie Munger

So let’s take a minute and discuss what kind of investments would fall into these punch card  investments. These investments should have a few commonalities. At this point I’ll paraphrase some investment thoughts from Warren Buffett. He says that when you’re investing, you should look for four things:

1. The investment should be one that you understand completely.  In other words, you should be able to understand what the business does and the economics of the business and the industry.
2. The company should have favorable long-term economics.  In other words, it should have an economic moat around it that allows it to achieve high returns year after year.
3. The company’s management should be able and trustworthy.  Stated a little differently, management should be good at their jobs and honest.  (I can’t emphasize this one enough . You may think that you have a great business on your hands, but if people at the helm are steering the ship the wrong way, it may all end in disaster.)
4. The investment should be one that you can purchase at a reasonable price (or, if you’re lucky, at an unreasonably low price).  In other words, investments should be purchased at reasonable/attractive valuations.

The second part of punch card investing is just as important. It’s the level of thought that needs to go into these 20 or so investments that you make over your lifetime. The idea here is that if you’re only investing in 20 or so different situations over the course of your life, you will spend a lot of time thinking about these situations and understanding them completely — inside and out. This is extremely important because after you invest in a situation, you need to have the fortitude to stick out any price declines that may come your way. When these price declines hit, you’ll need to be sure that what you’re investing in has way more value than the current price. This will give you the certainty, fortitude, and patience to wait out any price declines and eventually realize a gain on your investment (assuming that your original thesis and research is correct).

Punch card investing is not exciting or flashy.  It requires diligence, patience and the right temperament.  However, this method of investing, if practiced judiciously, can lead to extraordinary investment results.