Focus investing consists of several concepts. The first concept advises an investor to consider the benefits of creating a concentrated portfolio filled with investments selected for their quality and reasonable acquisition prices. The second concept states that the investing process should be conducted using a rational investing philosophy. The third piece of the puzzle deals with understanding the psychology of investing. The focus investor should also understand how to use a multidisciplinary approach towards the investing decision making process.

My concept of how the focused investment approach should be practiced is centered on five simple ideas:

1. Purchase understandable companies that have sustainable competitive advantages and management in place that have shareowner interests in mind. By following these criteria the investor should be able to continue to hold their shares for an extended period of time. Holding investments for an extended period of time has its own benefits: the compounding period is extended and tax payments are delayed.

2. Always invest using a margin of safety as advocated by Mr. Benjamin Graham in his seminal works, The Intelligent Investor and Security Analysis. The investor should endeavor to purchase part ownership of publicly traded companies for less than the present value of their discounted future free cash flows are worth today.

3. Concentrate your investment selections to avoid over-diversification. Focus Investors think differently than the majority of other investors. For instance, they believe that the way to be a successful investor is to only purchase their best investment selections. They also will invest significantly, both in terms of money and time spent studying the company's economic characteristics, in an investment when they believe the odds of a investment outperforming the market over a long time period are in their favor.

4. Always remember that the one element that an investor has complete control of is what price to pay when initially investing in a business.

5. Focus investors think of the concept of risk differently that the majority of other investors. A focused investor thinks of risk in terms of opportunity cost and permanent loss of capital. Volatility doesn't enter the picture as a type of risk; rather it provides the investor with possible opportunities to invest in companies at an advantageous price.

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What about diversification?

I believe that approximately 10-15 positions will supply more than an adequate amount of diversification. There are successful investors, Tweedy Browne for example, that have had hundreds of positions in their portfolios. For an individual investor it is impossible to understand that many businesses. It makes perfect sense to concentrate investment selections in companies that provide the highest probability of providing long-term investment gains. As Warren Buffett says, "Stick to your own circle of competence."

Does this approach work for everyone?

No. I believe it takes a rare psychological makeup that provides the investor with the ability to believe in their conclusions no matter what the "market" or other investing "experts" have to say. The courage to stand firm in your convictions can be a rare quality. Investors must be able to tune out the "noise" that comes from sources like CNBC. The Focus Investor also needs to be able to withstand swings in their portfolio valuations as focused portfolios are almost certainly to be more volatile than "normal" portfolios. The investor who follows this approach should also have a firm understand of how to determine a company's valuation. They must not kid themselves into believing they are investment experts. Put simply they must understand completely what they know and not kid themselves about what they do not know. I recommend the index fund approach to inexperienced investors.

Does this strategy have a better than average chance of beating the returns of the overall market?

Yes, it potentially does. Focus investing contains all the tools required for the investor to potentially beat the indexes, provided the investor is hard working, has the right mindset, and understands the investment process. The results achieved will almost certainly be more volatile than the average portfolio, however. This strategy in the hands of an inexperienced investor could also lead to not beating the market returns.

Why doesn't everyone practice this approach if it is so noteworthy?

My experience has shown that people either understand the value of the approach almost immediately (it is part of their "psyche") or they never seem to understand the key points. The ideas of wide diversification as a necessary component of investing combined with the idea of risk in the market being defined as volatility are so prevalent in mainstream thinking that most individuals have a hard time separating themselves from the crowd on these issues.

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"We say we are trying to buy into businesses with excellent economics, run by honest and able people at a decent price. We buy very few securities, so we look at it as "focused" investing." Warren Buffett, Conversations from the Warren Buffett Symposium, page 743

"Our policy is to concentrate holdings. We try to avoid buying a little of this or that when we are only lukewarm about the business or its price. When we are convinced as to attractiveness, we believe in buying worthwhile amounts." Warren Buffett, 1978 Berkshire Hathaway Letter to Shareholders

"It is a mistake to think one limits one's risks by spreading too much between enterprises about one knows little and has no reason for special confidence... One's knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself entitled to put full confidence." John Maynard Keynes, 1934

"The strategy we've adopted precludes our following standard diversification dogma. Many pundits would therefore say the strategy must be riskier than that employed by more conventional investors. We disagree. We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as 'the possibility of loss or injury." Warren Buffett, 1993 Berkshire Hathaway Letter to Shareholders

"The percentage of investors who own 25 or more different stocks is appalling. It is not this number of 25 or more which itself is appalling. Rather it is that in the great majority of instances only a small percentage of such holdings is in attractive stocks about which the investor has a high degree of knowledge. Investors have been so oversold on diversification that fear of having too many eggs in one basket has caused them to put far too little into companies they thoroughly know and far too much in others about which they know nothing at all. It never seems to occur to them that buying a company without having sufficient knowledge of it may be even more dangerous than having inadequate diversification." Philip Fisher, Common Stocks and Uncommon Profits, pages 108-109

"…if you know how to value businesses, it's crazy to own 50 stocks or 40 stocks or 30 stocks, probably because there aren't that many wonderful businesses understandable to a single human being in all likelihood. To forego buying more of some super-wonderful business and instead put your money into #30 or #35 on your list of attractiveness just strikes Charlie and me as madness." Warren Buffett's comments at the 1996 Berkshire Hathaway Annual Meeting

"Investing is where you find a few great companies and then sit on your ass." Charlie Munger's comments at the Berkshire Hathaway 2000 Annual Meeting "If you took out our 15 best ideas, most of you wouldn't be here" Charlie Munger's comments at the Berkshire Hathaway 2001 Annual Meeting

"…we try to exert a Ted Williams kind of discipline. In his book The Science of Hitting, Ted explains that he carved the strike zone into 77 cells, each the size of a baseball. Swinging only at balls in his "best" cell, he knew, would allow him to bat .400; reaching for balls in his "worst" spot, the low outside corner of the strike zone, would reduce him to .230. In other words, waiting for the fat pitch would mean a trip to the Hall of Fame; swinging indiscriminately would mean a ticket to the minors." Warren Buffett, 1997 Berkshire Hathaway Letter to Shareholders

"..but the important thing is that when you do find one where you really do know what you are doing, you must buy in quantity.... Charlie and I have made a dozen or so very big decisions relative to net worth, although not as big as they should have been. And in each of those, we've known that we were almost certain to be right going in." Warren Buffett's comments at the 1998 Berkshire Hathaway Annual Meeting

“I made a study back when I ran an investment partnership of all our larger investments versus the smaller investments. The larger investments always did better than the smaller investments. There is a threshold of examination and criticism and knowledge that has to be overcome or reached in making a big decision that you can get sloppy about on small decisions. Somebody says 'I bought a hundred shares of this or that because I heard about it at a party the other night.' Well there is that tendency with small decisions to think you can do it for not very good reasons.” Warren Buffett Talks Business, The University of North Carolina, Center for Public Television, Chapel Hill, 1995

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Mr. Warren Buffett's Letters to Berkshire Hathaway Shareholders

Berkshire Hathaway Annual Meeting Notes

Clipper Fund: Letters to Shareholders

Longleaf Partners Fund: Quarterly and Annual Reports

The Warren Buffett Portfolio by Robert Hagstrom

Latticework: The New Investing by Robert Hagstrom

The Intelligent Investor by Benjamin Graham

Influence: The Psychology of Persuasion by Robert B. Cialdini

Common Stocks and Uncommon Profits by Philip Fisher

Beyond Greed and Fear by Hersh Shefrin

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They also have the best compensation system structure that I have even seen! Here is their description of their management fee structure: "Essentially what we have created is a process whereby we will assess a performance fee when your portfolio moves into new high ground. By new ground, we mean over and above the highest value your portfolio has achieved while under our guidance (exclusive of withdrawals and contributions). The wealth-sharing performance fee calculation is relatively straightforward: ninety percent of the new wealth created accrues to you and the remaining ten percent is the fee paid to Martin Capital Management as a form of sharing in the wealth created. During any period of time when the portfolio value is less than any previous "high water mark," we will assess a minimal quarterly keep-the-lights-on fee of 1/8 of 1%. Please understand, we pay all commissions and related account administration charges (if securities are held in safekeeping by McDonald & Company) - whether we earn a performance or subsistence fee. There are no hidden charges. We feel very strongly that if we cannot find investments that lead to growth in we should not charge you as though we did."

Fairholme Capital Management (Ticker: FAIRX)
Internet Site:www.fairholmefunds.com
Morningstar Report
Comments: Fairholme believes in the focus investing principles evidenced by their fund being one of the few funds in existence that has a truly concentrated portfolio. I would recommend a close examination of their Internet site for information on how they view investing.

Clipper Fund (Ticker: CFIMX)
Internet Site:www.clipperfund.com
Morningstar Report
Comments: This fund was founded in 1984 and has established a successful track record. They believe in a disciplined approach towards investing, only invest when a company is selling for 70 percent of its intrinsic value and their is a margin of safety surrounding the investment decision. They also believe in portfolio concentration as they state here: "We believe that concentrated portfolios produce superior long-term performance. We concentrate on our best ideas subject to reasonable portfolio diversification. Our portfolios generally contain between 20 to 35 stocks. We hold these positions for extended periods of time resulting in low portfolio turnover."  

Sequoia Fund (Ticker: SEQUX)
Internet Site:www.sequoiafund.com
Morningstar Report
Comments: This fund was originally created at the suggestion of Warren Buffett so his partners would have the opportunity to stay invested in the equity markets after he closed his investment partnership. Its investment objective is: "[to achieve] long-term growth of capital. In pursuing this objective, the fund focuses principally on common stocks that it believes are undervalued at the time of purchase and have potential for growth. A guiding principal is the consideration of common stocks as units of ownership of a business and the purchase of them when the price appears low in relation to the value of the total enterprise. No weight is given to technical stock market studies. The balance sheet and earnings history and prospects of each investment are extensively studied to appraise fundamental value." This fund has been closed to new investors.

Chieftain Capital Management
No known Internet site
Comments: This investment management company (Glenn Greenberg and John Shapiro are the two partners) normally owns 8 to 10 companies in their portfolio. From 1984 through 2000 the management achieved a 25 percent compounded annual growth rate. This favorably compares to the 16 percent return the S&P 500 achieved. If anyone wishes to learn more about this company I would suggest reading Value Investing: From Graham to Buffett and Beyond.

Longleaf Partners Fund (Ticker: LLPFX)
Internet Site:www.longleafpartners.com
Morningstar Report
Comments: This focused fund has a superb long-term record. Here is how they describe themselves: "We are value investors. The funds seek to achieve superior long-term performance by acquiring equity securities of financially strong, well-managed companies run by capable managements at market prices significantly below our assessment of their business value. We sell stocks when they approach our appraisal. Equities purchased at prices substantially less than their intrinsic worth protect capital from significant permanent loss and also appreciate substantially once the market recognizes the company's economic value." The management company believes in "eating its own cooking" and as such the employees are collectively the largest owners of the three Longleaf Funds.

Oakmark Select Fund (Ticker: OAKLX)
Internet Site:www.oakmark.com
Morningstar Report
Comments: This fund is managed by Bill Nygren and has a terrific record of performance. I would recommend investors examine the company's Internet site as it offers a wealth of information on how Bill Nygren thinks about investing.

Aldebaran Capital, LLC
Internet Site:www.aldebarancapital.com
Comments: Here is how the two managers describe their investment philosophy: "We share a simple, yet rarely practiced investment discipline that derives from the work of Benjamin Graham and his classic textbook Security Analysis (1934). Mr. Graham’s investment principles continue to have a profound impact on today’s most successful long-term investors, which include his protégé Warren Buffett, and a select few others. We are dedicated investment professionals who believe that delivering outstanding investment results requires a consistent philosophy, a commitment to value investing, and diligent/rational investment behavior. We have, and will continue to utilize this successful approach with our own capital and that of our clients." I would recommend reading their Letter to Clients as they are very well done.

The Ridgewood Group
Internet Site:www.ridgewoodgrp.com
Comments: The firm advertises that they are "...an investment advisor offering our money management services to clients looking for an intelligent and risk minimizing approach to investing." They describe their investment philosphy as "...our approach borrows heavily from the philosophies and methods of a number of outstanding investors, and Warren Buffett (as influenced by Benjamin Graham and Phil Fisher) in particular. In essence, we are value and growth at a reasonable price investors. We will, however, also take advantage of special situations in which the catalyst is an expected corporate event rather than underlying business performance."

Legg Mason Focus Trust (Ticker: FOCTX)
Internet Site: www.leggmason.com
Morningstar Report
Comments: This fund is managed by Robert Hagstrom who has written many very interesting books on Warren Buffett and focus investing.

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