Here’s a great excerpt from Joel Greenblatt’s interview on Masters in Business in which he provides a great example of why a concentrated portfolio makes sense, saying:
GREENBLATT: Right, well Warren Buffett has a good response to that as well. You know he says listen let’s say you sold out your business and you got $1 million and you are living in town and you want to figure out something smart to do with it. So you analyze all the businesses in town and let’s say there’s hundreds of business and you stick to — if you find businesses where the management’s really good, the prospects for the business are good, it’s run well, they treat shareholders well, and you divide your million dollars between eight businesses that you researched well in town, no one would think that’s imprudent, they would actually think that was pretty prudent.
But when you get to call them stocks and you get stock quotes daily on these pieces of paper that bounce around put people put numbers on it and volatility and all these other things where really it’s not that meaningful, you know from one sense if you’re investing in businesses and you did a lot of research and invested in eight different businesses with the proceeds of your sale, people would think you’re a pretty prudent guy.
All of a sudden if you invested in stocks and did the same type of work, people think you’re insane, and it’s just an interesting analogy that I was think of when people make fun of me that I was that concentrating.
RITHOLTZ: You know the flip side of that is imagine if we got prints minute by minute for the valuation of our homes, people would lose their mind, they wouldn’t be able to manage it. So that understanding —
GREENBLATT: Well, imagine if you had a theory of buying homes, I’m going to buy the ones that went up the most last three months or six months. I mean it’s a really good analogy. I usually use the house analogy when people asked me how do we go about in valuing stocks and people understand completely when they’re buying a house, there are certain things you would do and we don’t do any different than owning a business.
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