1. Fin 4201/8001 1 Focus Investing “Choose a few stocks that are likely to produce above- average returns over the long haul, concentrate the bulk of your investments in these stocks, and have the fortitude to hold steady during any short-term market gyrations.”

2. Fin 4201/8001 2 Focus Investing - Five rules CHOOSE = Find outstanding companies FEW = Less is More CONCENTRATE = Put Big Bets on High- Probability Events HOLD STEADY = Be Patient FORTITUDE = Don’t Panic over price changes

3. Fin 4201/8001 3 Find Outstanding Companies Graham part 12 tenets Consistent Franchise or low-cost Rational, honest, & skilled management

4. Fin 4201/8001 4 Less is More Fisher part Concentrate in outstanding firms Limit portfolio to firms you can comprehend Size - 10 is good number Scope - Circle of competence

5. Fin 4201/8001 5 Big Bets on High Probability Events Concentrate Weight best ideas most heavily Do your homework – have confidence in your “rightness”

6. Fin 4201/8001 6 Be Patient Hold Steady Think long term (10 years) Longer periods → economics of underlying business will dominate share price. Low turnover – (10 years → 10% turn)

7. Fin 4201/8001 7 Don’t Panic Fortitude Random walk Price changes happen – Mr. Market Shorter periods → ups and downs LTCM was right, just not soon enough

8. Fin 4201/8001 8 What about diversification? Good, if you don’t know much about the stock market and are happy with average returns with lower risk.

9. Fin 4201/8001 9 If not? Then focus, and you will have extreme returns: very high returns or very low returns. If you do it well, you have very high returns with higher volatility

10. Fin 4201/8001 10 Star investors of focus investing J.M. Keynes Charlie Munger Bill Ruane Lou Simpson Warren Buffett

11. Fin 4201/8001 11 John Maynard Keynes 1928-1945 Chest Fund (%) U.K. Market (%) Average Return13.2-0.5 Standard Deviation29.212.4 Minimum-40.1-25 Maximum5621.5 Range (Max – Min)96.146.5

12. Fin 4201/8001 12 Charlie Munger Partnership Ltd. 1962-1975 Partnership (%) Dow Jones Industrial (%) Average Return24.36.4 Standard Deviation3318.5 Minimum-31.9-23.1 Maximum73.244.4 Range (Max – Min)105.167.5

13. Fin 4201/8001 13 Sequoia Fund Managed by Bill Ruane 1971-1997 Fund (%)S&P 500 (%) Average Return19.614.5 Standard Deviation20.616.4 Minimum-24-26.4 Maximum72.337.5 Range (Max – Min)96.363.9

14. Fin 4201/8001 14 GEICO Lou Simpson 1980-1996 GEICO (%)S&P 500 (%) Average Return24.717.8 Standard Deviation19.514.3 Minimum-10-5 Maximum57.137.6 Range (Max – Min)67.142.6

15. Fin 4201/8001 15 Buffett Partnership Ltd. 1957-1969 Partnership (%) Dow Jones Industrial (%) Average Return30.48.6 Standard Deviation15.716.7 Minimum6.8-15.6 Maximum58.838.5 Range (Max – Min)5254.1

16. Fin 4201/8001 16 Berkshire Hathaway Inc. 1965-1997 Partnership (%) S&P 500 (%) Average Return24.912.9 Standard Deviation13.016.4 Minimum4.7-26.4 Maximum59.337.6 Range (Max – Min)64.0

17. Fin 4201/8001 17 Isn’t it possible that the performance of these successful focus investors is a matter of chance?

18. Fin 4201/8001 18 W.D.’s Stock Pick Newsletter (or could be Sports Betting Tips) Ignore transactions costs Split population in half Send each half a different pick Send winners next pick Repeat until hooked Charge through the nose

19. Fin 4201/8001 19 Three thousand focus investors 3000 portfolios containing 250 stocks. 3000 portfolios containing 100 stocks. 3000 portfolios containing 50 stocks. 3000 portfolios containing 15 stocks

20. Fin 4201/8001 20 Performance

21. Fin 4201/8001 21 Buffett’s answer (1984) Imagine a national coin-flipping contest in which 225 million Americans bet $1 on their guess. After each flip, the losers dropped out and the winners kept the pot and advanced to the next round.

22. Fin 4201/8001 22 After ten events, there would be 220,000 winners left who, by letting their winnings ride, would have gained $1024. After another ten tosses, there would be 215 winners, each with $1 million.

23. Fin 4201/8001 23 Business professors would claim that there is no skill, and this can be duplicated by 225 million coin-flipping orangutans.

24. Fin 4201/8001 24 However, if 40 of those winning animals came from the same zoo, wouldn’t we want to ask the zookeeper what he feeds his now very rich orangutans?

25. Fin 4201/8001 25 What are the odds? For buffet is weighted average. P(loss)*size of loss + P(gain)*amount of gain Set up Stock currently is $18 Announce possible takeover at $30 Stock price immediately goes to $27 Now what do you do: If you buy and deal goes through you make $3 If you buy and deal doesn’t price reverts to fair value ($18) or a loss of $9 Do your analysis and conclude a 90% chance of going through (.1)*(-9) + (.9)*(3) = $1.80 positive expected value. What is the return = 1.8/27 = 6.6% If deal takes 6 months ≈ 13.2% return How does this compare to alternatives.

26. Fin 4201/8001 26 Wells Fargo Bought @ $58 in 1990 – real estate loans (specialty of Wells) most vulnerable (earthquake, overbuilding, economic collapse) He figured probability of total collapse at 10% and that 10% of wells loans might go bad to the tune of 30% of principal =.1*.1*.3*$48 billion of loans = 144 million loss but before collapse wells was EBT = $1B ≈ pretty large margin of safety.