196 THE WARREN BUFFETT WAY
measuring your success solely by price change or comparing annual price
change to a common stock benchmark, you have the liberty to select the
best businesses available. There is no law that says you must include every
major industry within your portfolio, nor do you have to include 30, 40,
or 50 stocks in your portfolio to achieve adequate diversif ication.
Buffett believes that wide diversif ication is required only when in-
vestors do not understand what they are doing. If these “know-nothing”
investors want to own common stocks, they should simply put their
money in an index fund. But for the “know-something” investors, con-
ventional diversif ication into dozens of stocks makes little sense. Buffett
asks you to consider: If the best business you own presents the least f i-
nancial risk and has the most favorable long-term prospects, why would
you put money into your twentieth favorite business instead of adding
money to the top choice?
Now that you are managing a portfolio of businesses, many things
begin to change. First, you are less likely to sell your best businesses just
because they are returning a prof it. Second, you will pick new businesses
for purchase with much greater care. You will resist the temptation to
purchase a marginal company just because you have cash reserves. If the
company does not pass your tenet screen, don’t purchase it. Be patient
and wait for the right business. It is wrong to assume that if you’re not
buying and selling, you’re not making progress. In Buffett’s mind, it is
too diff icult to make hundreds of smart decisions in a lifetime. He would
rather position his portfolio so he only has to make a few smart decisions.
The Essence of Warren Buffett
The driving force of Warren Buffett’s investment strategy is the rational
allocation of capital. Determining how to allocate a company’s earnings
is the most important decision a manager will make. Rationality—dis-
playing rational thinking when making that choice—is the quality Buf-
fett most admires. Despite underlying vagaries, a line of reason permeates
the f inancial markets. Buffett’s success is the result of locating that line of
reason and never deviating from its path.
Buffett has had his share of failures and no doubt will have a few
more in the years ahead. But investment success is not synonymous with
infallibility, but it comes about by doing more things right than wrong.
The Warren Buffett Way is no different. Its success depends as much on