Berkshire Hathaway
In Reply To:
The Mystical Reading of the Charts

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By UsuallyReasonabl
December 23, 2002

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I'm not sure if you're really looking for a reply to the sarcasm, but I'll give you one (since no one else has) and we'll see how it goes.

Ah, and fundamental analysis always works.

Declaring that A does not work is not the same as declaring that B does. However, I would certainly contend that fundamental analysis, practiced by someone who is good at it, does work better than chart reading.

I wonder why people who pick stocks strictly on the fundies tend to "diversify" more than those who buy/sell based on the charts?

It is an attempt to diversify away the idiosyncratic risk of holding shares in any particular company. The analysis may be wrong, some unexpected event may occur, etc., so we don't put all of our eggs in one basket.

Having said that, I think you'll find the general consensus of those who follow Graham/Buffett, and of people on this board, is that the number of stocks held should be limited, and the portfolio should be "focused", to use the parlance. My particular preference is for 7-10 stocks, generally closer to 7. That may be more diversified than a TA practitioner, but it is extremely undiversified relative to most money managers' habits.

Holding so few stocks strikes a balance between the extreme risk of holding a single stock, and the mean-reverting effect of overdiversification.

It couldn't be that that one can't really be sure about price movements based on the fundies so risk is spread across multiple stocks, could it? Lack of conviction, eh?

As should now be clear, it is an attempt to diversify away some of the idiosyncratic risks of single stocks. No one with a brain investing on fundamentals is doing so without conviction. Also, a more accurate way of phrasing your first statement is that in the short term one can't be at all sure about price movements, and an isolated movement in a single stock could kill you, were you in that stock only.

Why don't fundie worshippers buy the best two or three stocks on margin and retire in 10 years?

I find some of your word choices rather caustic. Be that as it may, since you can be completely wiped out on margin many people here tend to avoid it. I'm also not clear on what you mean by "the best" stocks, or, assuming you mean those with the highest returns, why you would think that anyone claims that it is possible to pick "the best" stocks ahead of time. I would say that "market-beating" returns is the goal rather than "the best" returns; "market-beating" returns might not guarantee retiring in 10 years.

Having said all that, I will say that I personally have had sufficient confidence in my choices that I have twice let one position go to over 50% of my portfolio, and well out on margin. I don't recommend doing so, however -- it's too risky. But I mention it merely to let you know that someone, at least, has done successfully what you sarcastically suggest.

Your comments make me think that you have developed a rather inaccurate view of what value investing is all about. (I find that a lot among investors; I'm really not sure why, but I often get the impression that they are intimidated at the idea of attempting to analyze a company's numbers, so they choose to ridicule the process instead.) As an engineer (both of us are, actually) I would think that you would seek a method, which is logically defensible and seems to work, rather than in making slighting dismissals of something you don't really seem to understand. Assuming you are open to it, I would recommend you read some of the better books on value investing:


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