June 23rd, 2011
06:32 PM GMT
(CNN) – We’d all like to invest as wisely as Warren Buffett, wouldn’t we? And maybe we can, because helpfully he’s the kind of billionaire investor who believes in sharing his insights.
Google “Buffett sayings” and many of his do’s and don’ts are just a click away. You can get them in books too, not to mention Mr Buffett’s letters to shareholders of his investment company Berkshire Hathaway. Don’t waste time, as I did, on the quotes of Jimmy Buffett – not if it’s investment that interests you, anyway.
Some of the sayings attributed to W. Buffett (“Only when the tide goes out do you discover who's been swimming naked”) have a kind of folksy cleverness to them that make you think, “Yes, I see what you’re (allusively) saying!” Others are a lot more direct, and seem to offer common-sense prescriptions you can follow, like “I never invest in a business I don’t understand.” Well thanks, but who would?
In fact, lots of us certainly have, and probably will again. It’s harder to avoid than you might think.
Buffett, I believe, was talking about making sure, before he invests, that he understands how a company makes its money. How do I know so many people ignore this principle? Does the name Enron ring any bells? It was very popular around the turn of the century, and appeared very profitable. We now know the many investors who backed it understood very little about how it made money – because, in short, it didn’t: the part about big profits was all a fraud. But its market capitalisation didn’t grow to nearly $70 billion without a lot of people believing the hype.
This sort of thing isn’t new. The South Sea Company was the Enron of the early 1700s – the biggest and baddest trading company on the block. Its directors, wigs notwithstanding, were the smartest guys in the Georgian drawing room – they might have recognised Kenneth Lay and Jeffrey Skilling as their spiritual successors. And the investors who pumped up the South Sea Bubble knew just as little about what was really going on, as Enron’s shareholders nearly 300 years later.
Naturally these are the kinds of traps you would skip nimbly around, if you lived by the Buffett philosophy. But if I took his words really to heart, I’m afraid my stock investment options would be alarmingly restricted. I’ve been reading about the flotation of the fashion house Prada, and this is the sort of thing that troubles me. You could say it’s a fairly straightforward business: it makes bags, clothes and shoes, and runs stores – reassuringly old-fashioned, the anti-Enron, surely? But do I understand what makes someone pay $3,000 for a bag or $1,900 for a pair of boots? I’d be lying if I said yes – I mean, I’ve heard all about the quality, and it’ll-last-you-a-lifetime and all that…but really, isn’t it the Prada label that people are paying for?
In other words – it’s a fashion thing. If I was to invest, I’d be saying: I can see the future of fashion. Am I that confident? For me, putting my money on Dancing Boy to win the King George Stakes at Ascot next month would probably be less foolhardy.
I’m forced to conclude that the world’s most successful investor applies his own guidelines rather less strictly than this. His company is a long-term holder of Coca-Cola stock – which raises the question: does he know what’s in Coke? Did their people give him a glimpse – in a heavily guarded room swearing him to non-disclosure – of the secret formula? Or did he wing it, like the rest of us?
The dot.com industry? Well, that’s fine as far as attracting users, members and friends – but how many companies have figured out how to make them profitable? Oil companies? How they think they have a business that will still be around a couple of decades down the line – that’s what I don’t understand.
These are just the known unknowns. Like Donald Rumsfeld, I can’t rule out the possibility of unknown unknowns too. So should I just embrace the uncertainty and pile in? Interestingly – if you really do invest in companies you don’t understand, investing in lots of them is undoubtedly less likely to lose you money than only investing in one. Back me up on this, Mr Buffett! “Wide diversification is only required when investors do not understand what they are doing.” Er, thank you .. I think.
What I’m really looking for, it seems, is a business so simple, I could remain true to the ethos of investing only within the scope of my understanding. Readers with long memories – and a fondness for British TV of the 1970s – may recall a similar quest.
Back then, one comedy show was a must-see for me. The Goodies were a trio of well-meaning but hapless crusaders for justice. One episode had them turning their hand to advertising – but what product would they peddle? Their standards were high: nothing worthless, nothing with a whiff of rip-off, decadence or deceit. That ruled out nearly everything ... a suggestion was put forward: what about bread? “Too racy,” objected one Goodie. They settled finally on string… good, honest, useful string.
If there’s a parallel with my quandary, maybe this is what it tells us: the human race is lucky I’m not the only investor on earth – if I was, we might still be in the String Age. And I’m not saying Buffett’s way of doing things isn’t a sound investment principle – only that, if everyone lived by it all the time, the world could have turned out a different place. Who knows what far-fetched businesses might never have got off he ground. Home computers? Aircraft? Television? Heaven forbid.
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