Learn to invest with Buffett

Chapter 66

Chapter 11 Ignored by Wall Street but the most effective concentrated investment

Chapter 11 Section 1 In Buffett's view, what are the advantages of concentrated investment

Concentrated investment can not only reduce the risk but also increase the profit level, why not do it?

--Warren Buffett
In Buffett's eyes, the most optimal investment policy is concentrated investment, and he has verified this point with his decades of investment experience.But there seemed to be an unearthly charm in this way, to be so long in his favor.What advantages does it have over other strategies?The doubts in the mind still need to be further resolved.

Advantage [-]: The less you hold, the less risk you have
Buffett believes that in stock investment, investors expect each investment to have an ideal return.If investors concentrate their funds on the stocks of a few companies that are financially stable, have strong competitive advantages, and are managed by competent, honest and trustworthy managers, and buy the stocks of such companies at a reasonable price, the investment The probability of loss occurring is usually very small.

In addition, risk is also related to the investment time of investors.He explained that if you buy a stock today and expect to sell it tomorrow, then you are entering a risky trade.Predicting the probability that a stock price will climb or fall in the short term is like predicting the probability of heads or tails of a coin flip, you will lose half the chance.If you stretch out your investing horizon over several years, the chances of your trade turning into a risky trade are greatly reduced.Of course, what you buy must be a dominant stock.

For example, if you buy Coca-Cola stock this morning and sell it tomorrow morning, it is a very risky trade.But if you buy Coca-Cola this morning and hold it for 10 years, you reduce your risk to zero.

In order to avoid investment risks, many investors often disperse their funds in different stocks.Unlike investment gurus, they simply do not understand the nature of risk, and they do not believe that it is possible to make money while avoiding risk.What's more, while diversification is a way to minimize risk, it also has the unfortunate side effect of minimizing profits.

Advantage [-]: The less shares you hold, the more profits you can make

The outstanding investment experience of many investment masters and a lot of practice have proved that although the volatility of their investment returns far exceeds the market average level, their long-term average annual investment return rate has also far exceeded the market average level.It is impossible to obtain such a good total return by the method of diversification of investment, and at most obtain an investment return equivalent to the market average.

Because most investors choose diversification investment strategy according to the modern portfolio theory, the value strategy of continuous competitive advantage with concentrated investment has a certain competitive advantage.As Buffett said: "We would rather have a choppy 15% return than a steady 12% return."

Since Buffett took over Berkshire in 1965, the net value per share of Berkshire has grown from the original $19 to the current $50498, with a compound annual growth rate of about 22.2%.

If Buffett doesn't focus his investments, but adopts a traditional diversification strategy, holding a diversified stock portfolio including 50 stocks, then he basically has no advantage.Assuming a 2% weighting for each of Berkshire's holdings, the weighted return on diversification is only 20.1%, slightly better than the S&P 500's 1.2%.

It can be seen that investing the most funds in the stocks with the highest probability of winning is the biggest reason why Buffett has continued to make profits, and it is also the main reason why he has continued to beat the market for more than 40 years.

Contrast: Disadvantages of Traditional Decentralization

Disadvantage 1: An investor is very likely to buy stocks that he knows nothing about.

Every investor's understanding is very limited, and it is impossible to have a complete understanding of many companies in a short period of time.They are not familiar with the current operating conditions of the companies they invest in, let alone fully grasp the future development of these companies.

Disadvantage 2: The purpose of diversifying investment is to diversify risks, but while diversifying risks, it also diversifies returns.

When the market is always improving, when many investors see that the average return of their own stocks is only a little over 5%, while the returns of other stocks are 20%, 40% or even higher, they will definitely think: "If I hold How great it would be to have that stock.” So someone will sell some of their stocks after the so-called long-term follow-up (three months or less), and replace them with those that performed better some time ago. In this way, we can increase the types of investment, and believe that we can spread the risk and win greater returns.The purpose of investment is to make profits. This approach is understandable, but the effect is often counterproductive.In the end, you find that diversification does not bring you the wealth you want, because it has already dispersed your income invisibly.

Comparing the diversification and concentration investment strategies, the diversification strategy includes 100 different stocks, and the concentration strategy has 5 stocks.

If one stock in the diversified portfolio doubles in price, the value of the entire portfolio rises by 1%.But under the same conditions, the value of the entire portfolio in the centralized portfolio increased by 20%.For a diversified portfolio to achieve this goal, 20 stocks in the portfolio must double in price, or one of them must rise by 2000%.Now, which do you think is easier?The answer is self-evident.

Of course, looking at it the other way around, if a diversified investor loses one stock in half, his net worth drops only 0.5%.However, if it occurs in a concentrated portfolio, the investor's wealth will lose 10%.But is it easier to find 100 stocks that are less likely to halve or 5 stocks that are less likely to halve?The answer is also self-evident.

The following is an excerpt of Buffett's stock portfolio concentration and investment return rate from 1994 to 2003.

Year Number of major stocks held Cost/Millions of US dollars Market value/Millions of US dollars as a percentage of the portfolio Investment rate of return

1994104555.66113973.272100.00% 206.72%
199574366.10019344.90087.93% 343.07%
199685975.70024455.20088.12% 309.24%
199785029.80031780.50087.68% 531.84%
199874361.00032130.00086.22% 636.76%
199964023.00030160.00081.50% 649.69%
200053699.00028118.00074.74% 660.15%
200174440.00022949.00080.03% 416.87%
200284543.00022980.00081.02% 405.83%
2003105652.00030605.00086.73% 441.49%
Total7646645.261256495.900853.97%4601.66%
Annual average 7.64664.52625649.59083.397%460.166%
In short, concentrated investment has a greater probability of beating the market than decentralized investment. From the above data analysis, we can see:

1. Out of 3000 combinations of 15 checks, 808 combinations beat the market.

2. Out of 3000 combinations of 50 stocks, 549 combinations beat the market.

3. Out of 3000 combinations of 100 stocks, 337 combinations beat the market.

4. Out of 3000 combinations of 250 stocks, 64 combinations beat the market.

也就是说，在投资组合中选择15只股票，战胜市场的概率是1/4；而在投资组合中选择250只股票，战胜市场的概率只有1/50。

In the above analysis, transaction costs have not been taken into account.If transaction costs are considered, the more dispersed the investment, the greater the transaction costs and the lower the probability of beating the market.On the contrary, the more concentrated the investment, the lower the transaction cost, and the greater the probability of beating the market.

In investment operations, investors who "know a little bit about investment" had better focus on a few companies.

Investment motto:

If investors can clearly understand the economic situation of the company, and invest in the few companies that they know best, have reasonable prices and great profit potential, they will get more investment returns.Judging from the current investment environment, finding 3 to 5 companies with long-term competitiveness from the market for long-term investment is the best investment portfolio for investors.

(End of this chapter)