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hey guys today we'll be looking at a question from the 1996 birkshire heatherway annual conference on how many stocks you should own in your portfolio it's a common question from investors so let's get into it my name is Mark H I'm from Scottsdale Arizona and I'm very interested in your policies on diversification and also how you concentrate your Investments and I've studied your annual reports going back a good number of years and there's been years where you had a lot of stocks in your marketable Equitable Securities portfolio and there was one year where you only had three in 1987 um so I have two questions um given the number of stocks that you have in the portfolio now what does that imply about your view of the market in terms of is it fairly valued that kind of uh idea and second of all uh whenever you it seems that whenever you take a new investment you never take less than about 5% and never more than about 10% of the total portfolio with that new position and I wanted to see if I'm correct about that yeah well on the second point that there that really isn't correct we uh we have positions which you don't even see because we only listed the ones above 600 million in the last report and obviously those are all smaller positions sometimes be that's because they're smaller companies and we couldn't get that much money in sometimes it's because the prices moved up after after we bought them and sometimes it's because we may be selling the position down even but uh so we have no there's nothing magic we like to put a lot of money in things that uh that we feel strongly about and that gets back to the diversification question um you know we we think diversification is as practice generally makes very little sense for anyone that knows what they're doing uh they diversification is a protection against ignorance I mean if you want to make sure that nothing bad happens to you relative to the market you own everything there's nothing wrong with that I mean that that is a perfectly sound approach for somebody who who does not feel they know how to analyze businesses Warren touched on a few things here first he mentions the difficulty larger investors like Berkshire heatherway have buying stock in smaller companies he mentions the stock price of these smaller companies can move quickly when he makes an investment this is a lot of investors follow Warren Buffett so as soon as it becomes public news a lot of others rush in as well and with extra demand for something the price often follows now smaller companies often have lower liquidity which explains the ease of buying into or selling out of an investment so if you have a smaller company and there's a lot of people wanting to buy the stock the price will rise really quickly as there's not enough liquidity to go around on the otherand if you have a larger company that has a lot more liquidity it's easier to make large Investments as Burkshire often does another issue that he didn't mention during the response is one of materiality burshire heatherway is worth nearly a trillion dollar so 0.1% of their Capital represents a billion dollar now to purchase a billion dollars of stock in smaller companies would not go unnoticed by the market this could potentially cause the stock to surge as Market analysts notice a whale or large invest taking such a position the same applies in Reverse when trying to sell moreover even even if the position doubled in value it wouldn't be material to the overall value of Burkshire as retail investors we have a chance to find opportunities in the market that larger investors like Buffett can no longer enter they're restricted to larger companies that are a worth Buffett's time and B can handle the amount he tends to invest the second thing that Buffett mentions about diversification is being a protection against ignorance he goes on to say that it's only good for those who don't know how to analyze a business now this isn't meant to be an insult as buffer is a huge advocate for lowcost index investing however this view is in the context of a Layman who hasn't got all day to research stocks Buffett has spent a lifetime researching stocks in more detail than any reasonable person can that holds down a full-time job so diversification is a defensive strategy for those who don't know or don't have the time to analyze companies for this group broad diversification such as lowcost index fund investing is a safer choice choice if you know how to analyze businesses and value businesses it's crazy to own 50 stocks or 40 stocks or 30 stocks probably uh because there aren't that many wonderful businesses at that are understandable to a single human being in all likelihood and it and to have some super wonderful business and then put money in number 30 or 35 on your list of attractiveness and and forego putting more money into number one just strikes Charlie in me as as as Madness and it's conventional practice and it it it may uh you know if all you have to achieve is is average uh it it's uh it it's May preserve your job but it's it's a confession in our view that you don't really understand the businesses that you own um you know I Bas I mean on a personal portfolio basis you know I own one stock you know but it's a business I know it and it leaves me very comfortable H so do I do I need to own 28 stocks in order you know have proper diversification you know uh be nonsense and within birkshire I could pick out three of our businesses and I would I would be very happy if they were the only businesses we owned and I had all my money in Berkshire now I love it the fact that we can find more than that and that we keep adding to it but three wonderful businesses is is more than uh it's more than you need in this life to do very well man buffer continues on from his earlier comments here he makes the case that it's better to invest in a couple businesses that you know extremely well then to invest across 30 to 50 you are moderately well versed in in recent years there have been many retail investors that have heavily invested into Tesla or nvidia's stock or even Bitcoin breeding into every single thing that's published about them this is the level of expertise Buffett expects investors to have when going for the strategy if you don't have the time or expertise it's better to settle for a market return through lowcost index funds like the S&P 500 and uh the average the average person isn't going to run into that I mean if you look at how the fortunes were built in this country uh they weren't built out of a portfolio of 50 companies they were they were built by someone who who uh identified with this with a wonderful business Coca-Cola is a great example a lot of Fortunes have been built on that and there aren't 50 coca-colas you know there aren't 20 if there were it'd be fine we could all go out and diversify like crazy among that group and and get results that would be equal to owning the really wonderful one but you're not going to find it and uh and the truth is you don't need it I mean if if you have a really wonderful business is very well protected against against the vicisitudes of the economy over time and and and competition I mean you know we're talking about businesses that are resistant to effective competition and and three of those will be better than a 100 average businesses uh uh and and they'll be safer incidentally I mean they there is less risk in owning three easy to identify wonderful businesses there than there is in owning 50 uh well-known big businesses here Buffett describes what he's looking for in a great business often it's called an economic moat this term encompasses all the factors that protect the business from competitors stealing market share C for example has one of the greatest Moes of any business Coca-Cola stock as you know we've never sold a share and I wouldn't think of selling a share if you're looking for a wonderful business was hard to beat Coca-Cola they have extremely strong Retail Partners Global presence enormous economies of scale and vertical integration and customers are extremely loyal I even saw that Costco in the United States is now switching from Pepsi to Coca-Cola and we've seen this with KFC here in New Zealand as well so Coca-Cola is globally dominant in that Cola space the specific things that Buffett has really liked about Coca-Cola in its economic Moes is its simple business model and its strong cash generation irrespective of economic conditions so when buffer advocates for investing in a couple great businesses over a lifetime he is talking about such businesses with a strong economic Mo simply prioritize quality over quantity of businesses and uh uh it's amazing what has been taught over the years in finance classes about that but uh uh I can assure you that that uh I would rather pick if if I had to bet the next 30 years on the fortunes of uh of my family that would be dependent upon the income from a given group of businesses I would rather pick free businesses from those we own than own a diversified group of 50 Charlie yeah what he's saying is that much of what is taught in modern corporate finance courses is twaddle do you want to elaborate on that Charlie you cannot believe this stuff I mean it's a modern portfolio Theory and yeah it's it's it has no utility but I mean it it you know it will tell you how to do average but you know I I I I think anybody can figure out how to do average in fifth grade I mean it it's just not that difficult and it's it's elaborate and you know there's lots of Little Greek letters and all kinds of things to make you feel that you're in the big leagues but it uh there is no value added I have great diffic difficulty with it because I am something of a student of dementia and I I have we hang around a lot together I get ordinarily classified dementia you know on some uh Theory structure of models but the modern portfolio Theory uh it involves a type of dementia I just can't even classify something very strange is going on here we see the pair criticize corporate finance courses for overco complicating investing now I've sat in a few such cases at University as well as one on value investing and you know what it's it's very true they bog down Finance into mathematical formulas to approximate portfolio risk here is the modern portfolio theory that talking about it argues that adding stocks to a portfolio should not be viewed in isolation but rather by how it affects a portfolio's overall return and risk theoretically we can add stocks to a portfolio that result in Greater returns without adding greater risk based on their correlation to existing positions Buffett and Munga say to ignore the academic Theory and simplify the process by just picking great businesses that are well understood invest in what you know and ignore the unnecessary complexity if you find if you find three wonderful businesses in your life you'll get very rich and and if you understand them bad things aren't going to happen to that those three I mean that that's the characteristic of it uh by the way maybe that's the reason there's so much dementia if you believe what Warren said you can teach the whole course in about a week here we see the pair of them reinforce the philosophy that great investing doesn't require complicated formulas but instead it's about understanding great businesses for retail investors it's an endorsement of Simplicity and not overthinking the last line from manga is a stab at how academic institutions try to over complicate the topic as the topic of value investing could be taught in just the week and to be fair these guys are certainly the greatest investors of our lifetime so they certainly know this stuff yeah and the high priest wouldn't have any edge of the lay people and that that never sells well right Buffett of course wraps up by emphasizing that successful investing doesn't require complex strategies focus on the basics invest in quality and if you know how to analyze businesses well ignore the over complicated academic theories I enjoyed this Q&A answer from Buffett and manga we shouldn't make the mistake of them downplaying diversification as it needs to be looked at in context these guys have spent a lifetime researching stocks finding the ab abolute cream of the crop among the 6,000 plus listed companies in America so for them they have observed some companies over several decades and often spend months with their investment team scaring every piece of knowledge on a company those of us with other commitments outside of investing would find it difficult getting to the level of understanding they'd expect before making an investment so in that context that'd be a strong advocate for a Layman to invest in a broad-based market index and get a fairly average Market return let's not forget that Buffett owns a large share of broadly Diversified spy units and is often advocated for them in the context of retail investing if you like this video check out some of the others that I've made somewhere over here before you leave make sure to hit the Subscribe button and I look forward to catching you on the next one cheers oh
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