Geoff Gannon December 24, 2005

On Business Risks and Market Risks

Investors in stocks are faced with two very different types of risks: business risks and market risks. Business risks can be managed through selectivity and spatial diversification. First, only the best (and best understood) firms are selected. Then, an investment is spread over several of these firms to ensure that the very small risk of a loss of principal inherent to each of these stocks does not adversely affect the portfolio. Five to ten stocks are more than adequate, provided they are businesses of the finest quality obtained at bargain prices. Market risks should not be combated with spatial diversification, because this forces the investor to accept issues of inferior quality. Instead, market risks must be managed through temporal diversification. Eventually, the market will recognize a firm’s intrinsic value. Therefore, a superior business will always command a superior price – in time. As long as an investor can hold a stock forever, he needn’t worry about market risks, and can devote himself entirely to an analysis of business risks.