Managing Your Portfolio 161they provide a method for isolating the companies with the best chance
for high economic returns. Buffett uses his tool belt to f ind companies
with a long history of superior performance and a stable management,
and that stability means they have a high probability of performing in
the future as they have in the past. And that is the heart of focus invest-
ing: concentrating your investments in companies with the highest
probability of above-average performance.
“Less Is More”
Remember Buffett’s advice to a know-nothing investor—to stay with
index funds? What is more interesting for our purposes is what he
said next:
“If you are a know-something investor, able to understand busi-
ness economics and to f ind f ive to ten sensibly priced companies that
possess important long-term competitive advantages, conventional
diversif ication ( broadly based active portfolios) makes no sense for
you.”^4
What’s wrong with conventional diversif ication? For one thing, it
greatly increases the chances that you will buy something you don’t
know enough about. Philip Fisher, who was known for his focus port-
folios,although he didn’t use the term, profoundly inf luenced Buffett’s
thinking in this area. Fisher always said he preferred owning a small
number of outstanding companies that he understood well to a large
number of average ones, many of which he understood poorly.
“Know-something” investors, applying the Buffett tenets, would
do better to focus their attention on just a few companies. How many
is a few? Even the high priests of modern f inance have discovered that,
on average, just f ifteen stocks gives you 85 percent diversif ication.^5 For
the average investor, a legitimate case can be made for ten to twenty.
Focus investing falls apart if it is applied to a large portfolio with dozens
of stocks.
“Put Big Bets on High-Probability Events”
Phil Fisher’s inf luence on Buffett can also be seen in another way—his
belief that the only reasonable course when you encounter a strong op-
portunity is to make a large investment. Warren Buffett echoes that