Preface

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With The Warren Buffett Way, my goal was to outline the investment tools, or tenets, that Warren Buffett employs to select common stocks, so that ultimately readers would be able to thoughtfully analyze a company and purchase its stock as Buffett would.

The book's remarkable success is reasonable proof that our work was helpful. With over 600,000 copies in print, including twelve foreign-language translations, I am confident the book has endured sufficient scrutiny by professional and individual investors as well as academicians and business owners. To date, feedback from readers and the media has been overwhelmingly positive. The book appears to have genuinely helped people invest more intelligently.

As I have said on many occasions, the success of The Warren Buffett Way is first and foremost a testament to Warren Buffett. His wit and integrity have charmed millions of people worldwide, and his intellect and investment record have, for years, mesmerized the professional investment community, me included. It is an unparalleled combination that makes Warren Buffett the single most popular role model in investing today.

This new book, The Warren Buffett Portfolio, is meant to be a companion, not a sequel, to The Warren Buffett Way. In the original work, I unwittingly passed lightly over two important areas: structure and cognition—or, in simpler terms, portfolio management and intellectual fortitude.

I now realize more powerfully than ever that achieving above-average returns is not only a matter of which stocks you pick but also how you structure your portfolio. To successfully navigate a focus portfolio, you need to acquire a higher-level understanding of price volatility and its effect on individual behavior, and you need a certain kind of personal temperament. All these ideas come together in The Warren Buffett Portfolio.

The two companion books fit together this way: The Warren Buffett Way gives you tools that help you pick common stocks wisely, and The Warren Buffett Portfolio shows you how to organize them into a focus portfolio and provides the intellectual framework for managing it.

Since writing The Warren Buffett Way, all of my investments have been made according to the tenets outlined in the book. Indeed, the Legg Mason Focus Trust, the mutual fund that I manage, is a laboratory example of the book's recommendations. To date, I am happy to report, the results have been very encouraging.

Over the past four years, in addition to gaining experience managing a focus portfolio, I have had the opportunity to learn several more valuable lessons, which I describe here. Buffett believes that it is very important to have a fundamental grasp of mathematics and probabilities, and that investors should understand the psychology of the market. He warns us against the dangers of relying on market forecasting. However, his tutelage has been limited in each of these areas. We have an ample body of work to analyze how he picks stocks, but Buffett's public statements describing probabilities, psychology, and forecasting are comparatively few.

This does not diminish the importance of the lessons; it simply means I have been forced to fill in the blank spaces with my own interpretations and the interpretations of others. In this pursuit, I have relied on mathematician Ed Thorp, PhD, to help me better understand probabilities; Charlie Munger, to help me appreciate the psychology of misjudgment; and Bill Miller, to educate me about the science of complex adaptive systems.

A few general comments about the structure of the book are in order. Imagine two large, not quite symmetrical segments, bracketed by an introductory chapter and a conclusion. The first chapter previews, in summary fashion, the concept of focus investing and its main elements. Chapters 2 through 5 constitute the first large segment. Taken together, they present both the academic and the statistical rationales for focus investing, and they explore the lessons to be learned from the experiences of well-known focus investors.

We are interested not only in the intellectual framework that supports focus investing but also in the behavior of focus portfolios in general. Unfortunately, until now, the historical database of focus portfolios has contained too few observations to draw any statistically meaningful conclusions. An exciting new body of research has the potential to change that.

For the past two years, Joan Lamm-Tennant, PhD, and I have conducted a research study on the theory and process of focus investing. In the study, we took an in-depth look at 3,000 focus portfolios over different time periods, and then compared the behavior of these portfolios to the sort of broadly diversified portfolios that today dominate mutual funds and institutional accounts. The results are formally presented in an academic monograph titled "Focus Investing: An Optimal Portfolio Strategy Alternative to Active versus Passive Management," and what we discovered is summarized, in nonacademic language, in Chapter 4.

In Chapters 6 through 8, the second large segment of the book, we turn our attention to other fields of study: mathematics, psychology, and the new science of complexity. You will find here the new ideas that I have learned from Ed Thorp, Charlie

Munger, and Bill Miller. Some people may think it strange that we are venturing into apparently unrelated areas. But I believe that without the understanding gained from these other disciplines, any attempt at focus investing will stumble.

Finally, Chapter 9 gives consolidated information about the characteristics of focus investors, along with clear guidance so that you can initiate a focus investment strategy for your own portfolio.

ROBERT G. HAGSTROM

-WAYNE, PENNSYLVANIA

FEBRUARY 1999

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