Saturday, 25 February 2012
Investors should Stay with What They Know
Knowing a company involves research as well as personal experience and successful investors approach share investment the way that they would the purchase of a business.
They buy a business in an industry area that they know or that they have learned about, they investigate the financials, they look at how the business operated in the past, they weigh up future potential, and they then make a reasoned decision to buy at the price offered or not buy.
Just as the cobbler should stick to his last, investors should stay with what they know. They should not stray into areas beyond their expertise. As Warren Buffett said in 1992:
‘What counts for most people in investing is not how much they know, but rather how realistically they define what they don’t know.’
Robert Hagstrom has looked extensively at Warren Buffett’s investments over the years and agrees that Buffett has made it his business to understand the business of the companies where he puts the money of Berkshire Hathaway. According to Hagstrom, Buffett:
‘understands the revenues, expenses, cash flow, labor relations flexibility and capital-allocation needs of each of Berkshire’s holdings.’
Hagstrom argues that the prudent individual investor should do no less.