June 23rd, 2011
06:32 PM GMT
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(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?
Whichever it is, the more I look at stocks, the more I realise how much I don’t understand. Are there any industries where I’d feel my investment was safe? Banking, say? Not any more, not now we know about all the credit default swaps and the collateralized debt obligations – the things their own executives admit they didn’t understand. Media? Let’s be honest, in the era of free online content, old-tech media bosses no longer understand how to convince anyone to pay for their expensively created content, so no.

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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soundoff (14 Responses)
  1. Kevin Lim

    How about this for starters? The Coca-Cola corporation has amazing market penetration in the Third World, especially in Africa. So much so that healthcare NGOs are tying up with Coca-Cola to use their delivery networks to deliver vaccines across the continent. There is no village in Africa so benighted that you can't get a hold of a bottle of Coke.

    Drawing from that, you only need to ask yourself, are Third World economies gonna be on the upswing in the medium term? One useful metric is mobile phone usage. If so, Coca-Cola will be the first to reap the rewards, and like Buffet you might wanna invest in Coke.

    June 24, 2011 at 5:31 am |
  2. Ravi Kant

    I agree with the author that if we plan to invest in a stock only when we fully understand the industry and the company, govt. legislation around the industry and other factors that could potentially impact the industry/company, we will certainly be not able to invest and in case we still manage to gather the necessary information, you will in all probability be behind the curve. To be ahead of the curve, you need a lot of money (like what Mr. Buffett has) to take calculated risks and invest based on limited but useful information. Diversification of the portfolio is definitely a golden principle for every investor including Mr. Buffett though people like Mr. Buffett can take risk and make more money by skewing the portfolio towards a particular industry or company which I am afraid, small investors cannot and shouldn't do.

    June 24, 2011 at 6:23 am |
  3. eclectic

    Capitalism was good till we had to evolve certain basic technologies. Now we are past that stage.

    Now its time to control population in the world through a moratorium on child production till the number reaches to 500 million or so, & switching to Resource based economic system or come up with even better economic system where a small population through equitable distribution of wealth & improved technologies can live a heavenly life with no or minimal suffering whether man made or natural.

    If we don't do that the humankind will be annihilated. Mr.Buffet & others are not philosophers, intellectuals, scholars, or scientists who can see that coming. All they know & all their intellect & wisdom could tell was to make money in the confines of capitalism, so no good for the betterment & survival of humankind.

    June 24, 2011 at 6:43 am |
  4. Macaulay Ayobami

    its impressive how someone can express a "theory" i've thought of before ,so to speak in such a clear cut manner. in the end we have to take difficult steps in the right direction, and learn from mistakes and if we are fortunate enough, we'l never have to.

    June 24, 2011 at 8:44 am |
  5. brij

    For investment follow your heart not the greed

    June 24, 2011 at 8:55 am |
  6. Jonathan

    Interesting title! Too bad about the content. Stopped reading 1/3 of the way through. Read the punch line though! Your implication that if everyone invested like Buffet we'd never have computers, aircraft and television is amusing, at best.

    June 24, 2011 at 9:06 am |
  7. Michael_gr

    You're being too literal; regarding Prada, you DO understand how it works. Sure, you don't know if it will continue to be a popular brand and make a profit in the future, but that's not the same as "understanding", that's the "faith" part of investing.

    June 24, 2011 at 9:27 am |
  8. just sayin'

    The author is full of blather. He doesn't even understand that Buffet does research. (Hint: get a clue.)

    Further, an investor, even if understanding an industry, doesn't bring in the profits consistently without a sixth sense. What the author seems to be pining after is the "sure thing," the guaranteed winner. That's how little this author understands investing. Buffet has lost many times more than the author will ever make in his lifetime.

    One shouldn't aspire to investment riches, or profess to have any insight regarding such matters, unless one can tie one's shoes without too much trouble.

    June 24, 2011 at 1:33 pm |
  9. TheOldOne

    I notye the word "Prada".. what on earth is that?

    June 24, 2011 at 6:17 pm |
  10. Indonesian

    The string theory, like others theory, is a bullshit theory. Buffett's skills and sucess can not be imitate !

    June 25, 2011 at 7:59 pm |
  11. Greg Demmons

    This article is a bit dumb. As a former investment advisor, I was shocked at how this business operates. Brokers are trained to avoid educating investors, while vocalizing the opposite. Keeping clients ignorant was the way to make sure you were in control, again, while vocalizing the opposite. The whole stock industry is a fabricated business that does not actually reflect any real value, but values derived from the hype promotions. People must begin to realize that what you are doing when you invest is giving money to a company, largely to use as they see fit. What you hope is that later you can sell it to someone else who has bit into the hype, or that the company pays you a dividend in order to keep you invested in the stock. At some point in the future, when the world figures out that there is no way that markets can continue on an infinite rise, the market will collapse upon itself. It is being propped up now by banks, and huge multi-nationals as a way of keeping the money flowing. If we all invested like Warren Buffet, maybe this illusion of the stock market would have been revealed for what it is; a mirror of our own greed.

    June 28, 2011 at 10:24 pm |
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    June 29, 2011 at 7:36 am |
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