Tuesday, 6 October 2015

Pareto Principle: 80-20 rule

Lets first understand the definition of 80-20 rule; according to Wikipedia the definition is:
The principle was suggested by management thinker Joseph M. Juran. It was named after the Italian economist Vilfredo Pareto, who observed that 80% of income in Italy was received by 20% of the Italian population. The assumption is that most of the results in any situation are determined by a small number of causes.
Now let's understand this definition in the language which is simple for you and me.
“20% of work delivers your 80% happiness and output.”

In the financial terms even this rules apply. Your 80% of income is produced by your 20% of activities. In your companies also 80% of the revenue is generated by 20% of products. Surely, this is not hard and fast rule but this can be applied in different ways like suppose in your company 80% revenue is generated by 20% of employee. The ratio can differ but it might be somewhat like 80-20.

Now lets try to apply this rule to Value Investor: In share market you hear a lot of news, every minute, every hour and every day. Some things happen in any part of any country and these news channel will surely try to connect it with economy from different perspective; that’s their role so I am not blaming them. But if you observe them carefully you will find that for a value investor in the long term only 20% of these news will might deliver his or her 80% results. So, as a value investor you must focus on those 20% of news which would be really helpful to you.

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