The Pareto Principle In Our Economic & Investing Research

We are big fans of the Pareto Principle which derives from an observation made by a man named Pareto which noted that 80% of the land in Italy was owned by 20% of the population. We asked around and we had people tell us similar stories about how 80% of the profits come from 20% of the customer base or how with computer users 80% of the tech problems come from 20% of the user base.

While the principle isn’t universal and applicable to everything it doesn’t have to be for our purposes. It is well known that the stock market is largely owned by a small percentage of investors. When we conduct our research and analysis, we tend to focus on the big dollars, big companies, big profits, etc. We look at where 80% of the riches or potential riches are and focus our research in that area.

For example, with regards to oil companies, there are thousands of companies producing oil or gas however over 80% of the market and revenue is controlled by a tiny list of companies. While there may be “diamonds in the rough” within the smaller oil companies that will grow to larger ones, it isn’t worth our time to look at thousands of companies. We would rather look at the largest companies, analyze their portfolios, profits and projected outcomes and invest in those than worry about the thousand or so other companies.

The same holds true for almost every industry and our primary concern with investing is to ensure that we don’t lose money so we need to invest in companies with proven track records. On occasion we may encounter news, research or other factors that take us to some smaller opportunities but we will generally consider those speculative investments.

Our thesis is we want to invest for solid returns as the American demographic ages and spending patterns change so we will continue to review all of our investments through those lenses.