Ann: Trading Update, page-30

"Diversification is also an easy and very common excuse to be less stringent in our analysis. How many times have we heard investment advisors say "Allocate a small portion of your portfolio for more speculative stocks!" ? In my dictionary, this is just an excuse to skip thorough analysis and gamble in the name of investing.

Sometime ago I conducted an analysis of my investment performance over the years. In particular, I wanted to see where the source of my returns are and where my losses are coming from. The finding was an eye-opener for me.

Most of my gains are from stocks that are high-quality, "expensive" and where I have a lot of stakes in because I have done a very deep analysis and have a thorough understanding of its competitive advantage."


@travelightor

I agree with almost everything in this post, so am a little reluctant to find fault. The punch-card precept is something I hold particularly dearly (for what it is worth, I have still got a fair way to go before I exhaust my 20 slots, and I'm no spring chicken).

Nevertheless, I think there may be a not-so-small flaw in your argument about "expensive stocks". Whilst I completely agree that strong moat businesses, especially those that can reinvest large portions of their earnings at high rates, but even if they pay out most of their earnings, will over the long haul generate the greatest wealth. And it is the long-haul, and the long-haul only, that ultimately matters in this game.

That said, I do not believe it rational, in the long-haul, to over pay for any business. Of course the question of what over paying is, is a long discussion in itself, and simple PE (or any other ratio) analysis will probably not suffice.

So I will just ask three questions: (a) In the last 10 years, how much of the gain from those high quality businesses, has come from PE expansion, versus earnings growth? (b) How much of that PE expansion has been driven by market and interest rate factors outside of your or my control? (c) How likely is it that such PE expansion will continue in the next 10 years?

So for my money, if it's a choice between buying mediocre businesses at bargain prices, or paying nose-bleed prices for quality, I will choose the former.