Investorial

After a satisfying dinner, some delicious desert would be nice. And if you’re Warren Buffett, you might be hoping for some Dairy Queen delights! As our series on Buffett’s tenets draws close to a conclusion, what can we do to leave you with a sweet remembrance? I hope you’re not too full after we’ve covered Buffett’s thoughts on the market, on selecting businesses, and on being an investor. We thought some thought-provoking contrary thoughts would be a thoughtful end! (sigh… I really need some writing lessons! Will somebody buy me a thesaurus?)

“Growth and value investing are joined at the hip.”
If the stock market were high school, the growth and value investors / fund managers would be rival gangs fighting for supremacy. Each camp believes firmly that their style — “focusing on fast-growing companies” or “focusing on bargain companies” — is the best. Can we all just get along?

Warren Buffett often describes himself as both a growth investor and a value investor, citing himself as a blend of Ben Graham and Phil Fisher. It’s a prudent way to reduce risks in your investments. You don’t want to overpay for growth. You also don’t want to buy a bargain that only stays stagnant. This is one of the reason that Buffett focuses on “best of breed” companies that have fallen out of favour. His portfolio of companies enjoys high growth rates, high return on assets / equity and he buys them when they are cheap.

So don’t be simply looking for bargains, nor should you be tunnel-visioned on growth-rates. By considering both techniques, it will make you a better investor!

“The advice ‘you never go broke taking a profit’ is foolish.”
This thought is quite controversial as many well-known investors advocate “systems” where if a position has fallen beyond a certain threshold that it’d be better to release that holding. And similarly, when it has risen beyond a threshold that it’d be prudent to take some profits. But Warren Buffett is greedy!

Yes, he’s greedy like a fox! (Editor: there’s no such saying!) You have to remember where Buffett is coming from. Buffett doesn’t pull the trigger unnecessarily. He buys with an owner mentality and he buys great businesses. If you were the owner of a great business, wouldn’t you want to keep reaping the rewards from your business?

I’d like to offer an example from hold-em poker. Pros often say that beginners play too many starting hands; getting themselves in trouble. In short, while beginners lament their luck on the river (not catching their hand), the problem starts at the very beginning when they decided to play a marginal hand. In this vein, many investors need to use a system where they are better off taking profits early because they get themselves into marginal stocks, marginal companies whose fortunes can turn on a dime. The constant fear that these marginal picks will manifest into nightmares turn emotional investors into jelly. Buffett avoids those tempting “singles” and would rather wait for the home-run pitch. That’s how he can keep his holdings the long-term.

“Risk can be greatly reduced by concentrating on only a few holdings.”
If you have a personal financial advisor, you’ve probably heard them advocate diversification; that you shouldn’t have your eggs in only a few baskets. So why would the world’s greatest investor contradict that rationale? Buffett wants to understand the investments that he makes. The in-depth understand Buffett insists upon requires a hands-on approach.

Which is easier? Becoming an expert on the operations of 5, 10 companies or becoming the expert on the operations of 30, 50, 100 companies? There is a method to Buffett’s madness. Similarly, is it easier to enjoy great investment performance from all 5 stocks, or easier to enjoy great investment performance from all 50 stocks?

What separates Buffett from the average investor is his temperment and discipline to think rationally about an investment. He is absolutely sure about his data and reasoning before pulling the trigger. And he’s more than willing to “miss the train” to ensure a high return-low risk situation is achieved. So he’s found the best combination — that there can be low-risk investments with the potential of high-returns. If you had that advantage, wouldn’t you concentrate yoru holdings? Here’s the kicker… everyone does have that advantage!

“Wide diversification is only required when investors do not understand what they are doing.”
Buffett has never said that diversification is a bad thing. I also agree that diversification is perfect for investors who don’t want to be bothered to do research. Hand over your money to someone else, or to a system (quantitative, index investing). Treat investing like a magical blackbox that promises to do “it’s best” to deliver you more money than you gave it.

Most fund managers are not paid to “make money” for you. They’re paid not to “lose money” for you. And the best way they know how not to lose money? Diversifcation. It’s the law of averages and a history of rising stock market on their side that drives that decision. Neither investor nor fund manager need to know what they’re doing as long as diversification is on their side! As long as fund managers pick enough stocks, there’s bound to be some semi-respectable stocks in their. Their jobs remain secure as long as diversification works in their favour. Perhaps this is also why most fund managers can’t beat the market indexes!

Speaking of indexes, you also don’t have to know what you’re doing when you invest in indexes. All you have to do is let the millions of investors collectively known as “the market” make those decisions for you. This way, you can remain ignorant of what’s going on. Now, if you only let the market decide on one stock without you knowing what’s going on, this is no worse than a coin-flip or hitting a number on the dart-board. That’s why you need to be diversified amongst hundreds of stocks. The law of averages works well against mindlessness because historically, markets trend upwards. I shutter to think that there’ll be a day when that this trend no longer holds true?

Final Thoughts
Again, thank you for bearing with me as we explored some of Buffett’s Tenets. This is by no means a comprehensive list. Feel free to add your thoughts and favourite tenets to the discussion!

Related Posts:

• Buffett’s Tenets - On The Market
• Buffett’s Tenets - On Selecting Businesses (Part 2)
• Buffett’s Tenets - On Being An Investor
• Money Buys Happiness?