Don’t invest in things that you don’t understand.
That’s a line from Warren Buffett, the billionaire investor and CEO of Berkshire Hathaway. The line gained popularity before and shortly after the tech bubble burst in the early 2000s.
Buffett didn’t jump on the tech stock bandwagon during the 1990s for a few reasons. First, many of these start-ups (like most start-ups) didn’t generate much in sales and no earnings. Second, even if the tech company started making money, Buffett couldn’t explain for himself how the business plan could succeed over the long-term.
The Berkshire Hathaway portfolio
Berkshire Hathaway is a holding company that has ownership in many different companies. As you scan down the list, you notice some pretty boring- but recognizable names:
All names you know, right?
The elevator speech
We’re all familiar with an elevator speech. How can you explain something in the time it takes to ride an elevator- just a minute or two? As an example, you might explain what you do for a living during an elevator ride. You’ve got to be clear and concise. (When people ask me what I do, I say: “Well, I’m a professional explainer. I explain things for a living.” A friend helped me come up with the idea.)
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Well, Buffett’s point is that he wants his investments to fit that same sort of criteria. You can look at the three names above and immediately have an idea about what their product or service is. Here’s more food for thought about those companies:
• Each has a big presence in their particular market
• Each sells a product that we all use (paint, apparel, insurance)
• A salesperson for each of these firms can probably use an elevator speech to explain the product or service
Ok- now this is starting to look like a reasonable investment approach.
A black box vs. a Lucite box
Over the years, I’ve gone on the road to speak at investment conferences. The audience at these meetings is financial advisors. Most of the speakers are money managers who are trying to get financial advisors to sell their products.
Many of the managers explain that they have a “proprietary model” for making investment decisions. Their logic is: “You’re paying us to use our black box to make better investment decisions than the money manager down the street”.
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Well, OK. In some cases, I can see hiring an expert that knows more than I do about a particular subject. I don’t know anything about medicine, which is why I go to a doctor for an illness.
However, I think Buffett’s approach is to use a Lucite box. This is a box with sides that you can see through. Buffett’s approach seems to be: “look, you know and understand how all of these companies make money. I’m simply packaging these companies together inside of a holding company. You could do this yourself- or invest in our firm and get just about the same thing”.
Some of both
When it comes to putting together a portfolio, maybe you need some of both. You want to own some companies that sell products and services that are easy to understand. These firms can be explained using an elevator speech.
You may also want some investments that are more cutting-edge. Some investors want to speculate through companies that use new technology. These businesses are harder to explain- but may offer higher rates of return.
Maybe you use some of both. As always, these thoughts are for educational purposes only.
Have used any of these ideas? I’d love to hear from you.
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
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