The Warren Buffett Way of Investing - Focus Investing Part 1
We just focus on a few outstanding companies. We’re focus investors. —Warren Buffett
Hey everyone,
In today’s newsletter, we’re diving into an investing approach I first encountered in 2020.
After four years of putting it into practice, I can say it doesn’t just work—it lets you sleep soundly at night. The approach is Focus Investing, also known as the Warren Buffett Way.
We’ll explore what makes this strategy unique, why it may be worth considering, and how it differs from other investing strategies.
Here's what we’ll cover:
What is Focus Investing?
Elements of Focus Investing
Challenges of Focus Investing
What’s Next: The Mathematics and Psychology of Investing (simplified)
Before starting, let’s be clear on what does investment means?
Investment means preservation of capital and generating returns on that capital. Anything other than that is a speculation.
Goal of a Focus Investor
As focus investors, our goal is to move from achieving average returns to above-average returns.
And three key differentiators that make you reach there are
View stocks as businesses - If you invest without understanding the economics and management behind the business, you’re not a focus investor.
Prioritize margin of safety - Pay significantly less than the stock’s actual worth to gain a competitive edge.
Cultivate a true investor attitude - By developing the right temperament and thinking in decades.
What is Focus Investing?
At its core, Focus Investing is straightforward:
Select a few companies likely to produce above-average returns over the long term.
Concentrate the bulk of your investments in these companies.
Have the fortitude to hold steady during any short-term market fluctuation.
Let’s break down each element of this approach.
1) “Find Outstanding Companies”
The basic common sense behind the approach is, if a company is doing well, and managed by smart and rational people, sooner or later it's inherent value will be reflected in stock price.
That being said, a focus investor work is
analyzing the economics of underlying business
and assessing it's management.
For this, Buffett has designed a tool kit known as ‘The Buffett Tenets’. The tenet helps isolate companies with the best chance to generate above average returns.
Here the tenets Buffett use -
The tool kit helps Buffett to find companies with a long history of superior performance with stable management. The Stability further indicates a high chance of company performing in the future as they performed in the past.
And that is the heart of focus investing:
Concentrating your investments in companies with the highest probability of above-average performance.
Till now, focus investing to me is common sense investing.
2a) “Less Is More”
For a know-nothing investor, it may be sensible to stay in index funds, which replicate market performance by investing in diversified stocks.
But for focus investors, diversification makes no sense.
Investors diversify to handle the price volatility or the fluctuation in prices of individual stocks. But since, focus investors time horizon extend to several years, the chances of it being a risky purchase decline meaningfully, given a sensible purchase have been made (say after take assistance from the toolkit).
Remember, the primary benefit of a broadly diversified portfolio is to mitigate the price volatility of the individual stocks. But if you are unconcerned with price volatility, as Buffett is, then you will also see portfolio diversification in a different light.
Source → From book The Warren Buffett Portfolio by Robert G. Hagstrom
For focus investor the fluctuation in prices is a friend, not foe.
Now we know we don't have to invest in 100 stocks but only a few.
But how many is a few?
For the average investor, a few can be anything between ten to twenty.
Focus investing will not work if applied to a large portfolio with dozens of stocks.
2b) “Put Big Bets on High-Probability Events”
After selecting a few promising companies, the next return-generating question is:
How much amount should I allocate to a certain stock?
Here's what Fisher and Buffett take on that -
Phil Fisher’s influence on Buffett can also be seen in another way—his belief that the only reasonable course when you encounter a strong opportunity is to make a large investment. Warren Buffett echoes that thinking: “With each investment you make, you should have the courage and the conviction to place at least ten percent of your net worth in that stock.”
Source → From book The Warren Buffett Way by Robert G. Hagstrom
Though the focus investor’s portfolio is well-researched and contain stocks likely to outperform, some stocks will still do better than others.
Stock with higher chance of performance should be allocated a greater portion of investment.
Poker players understand this intuitively. When the odds are strongly in their favor - like getting two aces - they place big bets.
How to place proportionate bets - the intuition, the conceptual understanding and the tool used (Kelly criterion) all I'll cover in my upcoming newsletter, Part 2 of Focus Investing series. Stay tuned!
Until then, remember what Mohnish Pabrai said:
“Few bets, big bets, and infrequent bets.”
3a) “Be Patient”
The most effective part of generating high returns is riding the ride i.e., holding your investments.
One of the challenges with focus investing is, with only a few companies in the portfolio, any price fluctuation in one stock is noticeable and has a larger impact overall.
Focus investing demands patience, especially
during periods of heightened volatility or
when other strategies appear more successful.
Staying calm through these fluctuations is key to both peace of mind and financial success.
But how long should we remain invested in a stock?
As you might imagine, there is no hard and-fast rule (although Buffett would probably say that anything less than five years is a fool’s theory). The goal is not zero turnover (never selling anything); that’s foolish in the opposite direction, for it would prevent you from taking advantage of something better when it comes along. As a general rule of thumb, we should aim for a turnover rate between 20 and 10 percent, which means holding the stock for somewhere between five and ten years.
Source → From book The Warren Buffett Way by Robert G. Hagstrom
Focus investing is necessarily a long-term approach to investing. If we were to ask Buffett what he considers an ideal holding period, he would answer "Forever"—so long as the company continues to generate above-average economics and management allocates the earnings of the company in a rational manner.
Source → From book The Warren Buffett Portfolio by Robert G. Hagstrom
Inactivity strikes us as intelligent behavior. - Warren Buffett
3b) “Don’t Panic over Price Changes”
In Focus Investing, price volatility isn’t a threat—it’s a natural byproduct.
Focus investors tolerate the bumpiness because they know that in the long run the underlying economics of the companies will more than compensate for any short-term price fluctuations.
Source → From book The Warren Buffett Way by Robert G. Hagstrom
When you invest in a small, select group of companies, it’s natural for their stock prices to fluctuate. As a focus investor you must embrace these fluctuations, knowing that the strong fundamentals of these companies will outweigh any short-term price dips.
Dos and Don’ts for Focus Investors
If you’re considering Focus Investing, keep these guidelines in mind:
Do not enter if you aren't willing to see stocks as part ownership in business.
Diligently study the business with the idea that nobody knows more about the business and industry than you do.
Do not start if you aren’t willing to invest for a minimum of 5 years. "Longer time horizons will make for safer rides"
Never leverage your focus portfolio.
Accept the need to acquire the right temperament and personality to drive focus portfolio.
Final Thoughts: A Note for Investment Students
According to Buffett, investment students need only two well-taught courses:
1. How to Value a Business, and
2. How to Think About Market Prices.
Focus investing is about carefully checking a 'vehicle' (business) before you buy it and knowing how to hold on during the ride.
Riding the vehicle i.e., keeping your investment even when prices go up and down, along with understanding market prices, is a big part of investing psychology. I’ll go into these topics more in the next part of the Focus Investing series.
If you’re finding these insights valuable, don’t miss out on the next update—subscribe now to stay ahead!
Until then, remember the importance of common sense and human psychology in investing.
Key Takeaways
1. View stocks as businesses.
2. Prioritize margin of safety.
3. Cultivate a true investor attitude
4. Find outstanding companies with a chance of giving above average returns.
5. Bet big when the odds are in your favor.
6. Educate yourself about
- How to Value a Business
- How to Think About Market Prices
Content Diet This Week
🔉 Arnold Van Den Berg on the Power of Your Subconscious Mind
🔉 Jason Zweig on the Principles of Intelligent Investing and the Enduring Wisdom of Ben Graham
📝 From the Archives: Daniel Kahneman by Jason Zweig
📚New Books
📖 Latest Edition (2024)- The Intelligent Investor by Jason Zweig
📖 The Warren Buffett Portfolio by Robert G. Hagstrom
📖 The Warren Buffett Way by Robert G. Hagstrom
P.S.
Thanks for reading Part 1 of the Focus Investing series! In the next edition, we’ll dive into the core math behind investing, covering probabilities and payoffs—key concepts for becoming a rational investor.
This week, I also took a deep dive into the work of Jason Zweig, the journalist known for his insightful commentary on The Intelligent Investor, often called the "Bible of Value Investing." Zweig has just released a new 2024 edition with updated insights reflecting today’s technology and market trends. It's worth a read!
See you guys next week!
#you_are_more
Great Read!