How a Focused Portfolio Beats the Market:

I recently finished reading the Warren Buffet Portfolio by Robert G. Hagstrom. The book was
recommended by Charlie Munger in one of the Berkshire annual meetings. Charlie praised the book for having
added to the TK of investing. I have summarized the key points that I took from the book that I think will help any
investor in their path to beating the market.

A Focused Portfolio: But What About Diversification?

Don’t put all your eggs in one basket. The first rule you are taught about investing is to DIVERSIFY. The
best way to guarantee you don’t lose all of your money is to own everything. Everything can’t go down at once
right? Hidden in the argument for diversification is that you can never be sure about any single thing.

But what if the basket is lined with Egyptian cotton, is made out of carbon fiber, and has a NASA drop-
proof cover on it to prevent any egg spillage. The top it off the basket is in a water-proof locked case inside a Swiss
Bank. Surely putting all of your eggs in that basket has a better chance of keeping the eggs safe than walking around
with 12 normal baskets hoping you don’t end up dropping any of them.

The safety of principal that diversification hopes to achieve can be reproduced to an even greater extent
through a carefully picked, focused portfolio.

What modern investing has created is a theory that believes the risk within a stock is derived from its past
price performance.

A Bumpier Road to a Better View

Volatility is the great friend of a long-term investor. Those who think about stocks as part ownership in
businesses understand that the intrinsic value of a business is slow to change. As the market peaks and troughs, long-
term thinkers can take advantage of the volatility to acquire great businesses at great prices.

The Kelly Optimization Model

Imagine for a second that you had a sure 100% bet to double whatever amount of money you put in in one
day. How much of your net worth would you place into that bet? I would hope that every single person answered
100% of your net worth. Now imagine the bet was now a 99% chance. Perhaps you would keep a little just in case
that 1 in a hundred chance occurred. How much would you bet in a 90%, 80%,…

2p - 1 = X

Gambling and mathematics have long been

How to beat the market: Patience

The final step to beating the market is patience. It will take time for the market to agree with your
fundamental research. As long as you do good valuation, the market will agree with you. You just have to wait until
it does.