Vilfredo Pareto

Vilfredo Pareto (1848-1923) was an influential Italian engineer, sociologist, and economist whose work has had a profound, if unexpected, impact on the world of investing. While he never wrote a stock-picking guide, his famous observation, now known as the Pareto Principle (or the 80/20 Rule), provides a powerful mental model for investors. The principle states that for many events, roughly 80% of the effects come from 20% of the causes. Pareto first noticed this pattern when he observed that approximately 80% of the land in Italy was owned by just 20% of the population. This “law of the vital few” has since been recognized everywhere: 20% of a company’s customers might generate 80% of its revenue, 20% of software bugs cause 80% of the crashes, and, most importantly for us, 20% of your investments will likely produce 80% of your returns. For a value investing practitioner, understanding this imbalance is not just a neat party trick; it's a strategic weapon.

Born in Paris to an exiled Italian noble family, Vilfredo Pareto was a true polymath. He began his career as a civil engineer, managing railways and iron works, before turning his analytical mind to economics and sociology later in life. He succeeded Léon Walras to the Chair of Political Economy at the University of Lausanne in Switzerland, where he made his most lasting contributions. The 80/20 rule wasn't a strict mathematical law but an empirical observation about imbalance and unequal distribution. Pareto noticed this power-law distribution in wealth data across different countries and eras. The key insight is that inputs and outputs are rarely, if ever, balanced. Effort, resources, and causes do not produce results in a neat one-to-one relationship. Instead, a small, “vital few” inputs are responsible for the lion's share of the results, while the “trivial many” contribute very little.

For investors, the 80/20 rule is a game-changer. It helps cut through the noise and focus on what truly matters. It's a philosophy that pairs beautifully with the teachings of investing greats like Warren Buffett and Charlie Munger.

Look at any successful long-term portfolio, and you'll likely see the Pareto Principle at work. A handful of superstar stocks typically drives the vast majority of the gains. It’s the single ten-bagger or the long-held compounder that does the heavy lifting, while many other holdings just tread water or produce modest returns. This reality challenges the idea of broad diversification for its own sake, a practice Munger has called “diworsification”. Why own your 50th-best idea when you can put more capital into your top five? The 80/20 rule suggests that investors should:

• Concentrate on high-conviction ideas: Focus your capital on the few businesses you understand best and that have the most attractive prospects.
• Let your winners run: Resista the urge to trim your biggest winners just because they have become a large part of your portfolio. These are the “vital few” that are generating your wealth. Cutting them is like benching your star player in the championship game.

The investment research process is a perfect candidate for an 80/20 audit. It's easy to get lost in an ocean of data: reading every news article, analyzing dozens of financial ratios, and building overly complex spreadsheets. The Pareto Principle reminds us that 20% of our research will yield 80% of the critical insights. This “vital few” in analysis often includes:

• Understanding the company's competitive advantage, or moat.
• Assessing the quality and integrity of its management team.
• Calculating a conservative estimate of its intrinsic valuation.
• Identifying the key drivers of long-term cash flow.

By focusing your time and energy on these core factors, you can make better decisions with less effort and avoid “analysis paralysis.”

The principle also applies when you analyze a company's operations. A smart investor looks for the 80/20 rule inside the business itself. For example, with a company like Apple Inc., for a long time the iPhone (one of a handful of products) generated a hugely disproportionate share of the company's profits. Ask yourself:

• Which products or services generate most of the profit?
• Which customers or geographic regions are the most valuable?
• What are the few critical variables that will determine 80% of this company's success or failure in the next decade?

Understanding this internal dynamic helps you identify both the core strengths of a business and its key vulnerabilities.

Vilfredo Pareto gave us a lens, not a formula. It’s a way to think smarter, not harder.

1. Focus your attention. Don't try to be an expert on everything. Concentrate your learning within your circle of competence and your capital in your best ideas.
2. Identify what moves the needle. In any investment decision, force yourself to identify the 2-3 factors that will truly drive the outcome. Ignore the rest.
3. Review your portfolio. Periodically check if your portfolio reflects this principle. Are a few big winners carrying the team? Are there underperforming “weeds” that are draining resources and attention? A portfolio is like a garden; it needs occasional, thoughtful pruning to let the best plants flourish.