Warren Buffett: Diversification Is For The IGNORANT

We think diversification, as practiced generally, makes very little sense for anyone that knows what they're doing. 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. That is a perfectly sound approach for somebody who does not feel they know how to analyze businesses. If you know how to analyze businesses and value businesses, it's crazy to own 50 stocks or 40 stocks or 30 stocks, probably, because there aren't that many wonderful businesses that are understandable to a single human being in all likelihood. And to have some super wonderful business and then put money in number 30 or 35 on your list of attractiveness and forego putting more money into number one just strikes Charlie and me as madness. Three wonderful businesses is more than you need in this life to do very well.

The really great business is one that doesn't require good management. That's a terrific business. And the poor business is one that can only succeed or even survive with great management. But we look for people that know their businesses, love their businesses, love their shareholders, want to treat them as partners, and we still look to the underlying business, though. If we have somebody that we think is extraordinary, but they're locked into one of those terrible businesses, because we've been in some terrible businesses, and, you know, the best thing you can do, probably, is get out of it and get something else. But there's an enormous difference, frankly. There's an enormous difference in the talent of American business managers. The CEOs of the Fortune 500 are not selected like 500 members of the American Olympic track and field team, and it is not the same process, and you do not have the uniformity of top quality that you get with the American Olympic team in any sport. You do not get that in top management in American business. You get some very able people, some terrific people, like a Bill Gates that we just mentioned, but you get a lot of mediocrity, too. And the test, I think in some cases that it's fairly identifiable who has done an extraordinary job. And we like people that have batted 350 or 360 in terms of predicting that they're going to bat over 300 in the future. And some guy says, you know, I batted 127 last year, but I've got a new batter, a new batting coach, you know, some management consultant has come in and told them how to do it, supposedly. We're very suspicious of that. So, we don't like banjo hitters those suddenly proclaim that they can become power hitters. And then we try to figure out what their attitude is toward shareholders. And that isn't uniform, either, throughout corporate America. It's far from uniform. We still want them to be in a good business, though. I would emphasize that. And we feel that I gave the illustration of Tom Murphy in the annual report. I mean, no one had either the ability—no one could top his ability or integrity in terms of the way he ran Cap Cities for decades. In terms of building the business, he only built it when it made sense, not when it did something for his ego or to make it larger alone. He did it when it was in his shareholders' interests. And they're not all Tom Murphys, but when you find them and they're in a decent business, you want to bet very heavily and not make the same mistake I made by selling out once or twice, too.

Yeah, well on the second point, that really isn't correct. 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 that's because they're smaller companies and we couldn't get that much money in, sometimes it's because the price has moved up after we bought them, sometimes it's because we may be selling the position down even. So we have no—there's nothing magic. We like to put a lot of money in things that we feel strongly about, and that gets back to the diversification question. We think diversification, as practiced generally, makes very little sense for anyone that knows what they're doing. 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 is a perfectly sound approach for somebody who does not feel they know how to analyze businesses. If you know how to analyze businesses and value businesses, it's crazy to own 50 stocks or 40 stocks or 30 stocks probably because there aren't that many wonderful businesses that are understandable to a single human being in all likelihood, and to have some super wonderful business and then put money in number 30 or 35 on your list of attractiveness and forego putting more money into number one just strikes Charlie and me as madness. And it's conventional practice and it may, you know, if all you have to achieve is average, it may preserve your job, but it's a confession in our view that you don't really understand the businesses that you own. You know, I mean, on a personal portfolio basis, you know, I own one stock, but it's a business I know and it leaves me very comfortable. So do I need to own 28 stocks in order, you know, have proper diversification? You know, that would be nonsense. And within Berkshire, I could pick out three of our businesses and I would be very happy if they were the only businesses we owned and I had all my money in Berkshire. Now I love the fact that we can find more than that and that we keep adding to it, but three wonderful businesses—it's more than you need in this life to do very well. And the average person isn't going to run into that. I mean, if you look at how the fortunes were built in this country, they weren't built out of a portfolio of 50 companies. They were built by someone who identified 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 get results that would be equal to owning the really wonderful one, but you're not going to find it. And the truth is you don't need it. I mean, if you have a really wonderful business, it's very well protected against the vicissitudes of the economy over time and competition. I mean, you know, we're talking about businesses that are resistant to effective competition. And three of those will be better than 100 average businesses. And they'll be safer, incidentally. I mean, there is less risk in owning three easy-to-identify wonderful businesses than there is in owning 50 well-known big businesses. And it's amazing what has been taught over the years in finance classes about that, but I can assure you that I would rather pick—if I had to bet the next 30 years on the fortunes of my family that would be dependent upon the income from a given group of business—I would rather pick three businesses from those we own than own a diversified group of 50. Charlie?

You want to elaborate on that, Charlie?