Why you shouldn't invest in companies whose business you don't understand?

You shouldn't invest in companies whose business you don't understand because you won't be able to judge their future potential and vulnerabilities.

While intimacy with a company's business is not essential to making a decision to buy the stock, later "hold" or "sell" decisions may be clearer if you understand its competitive position in the marketplace, the value of its products or services, and the character of its industry's problems.  These are common-sense issues for which a simple understanding of the business will suffice.

Why Warren Buffet does not Invest in Companies he does NOT Understand

COMPLEX COMPANIES

Take however, a company like Unilever NV. This is a corporation that has been around a long time, has a worldwide reputation and market, and is successful. But how easy is it to understand the way it operates?

According to Value Line, it has two parent holding companies, one in Great Britain, and one in The Netherlands. It operates as one company but each of the two holding companies owns shares in operating subsidiaries. The director component of both holding companies is the same and there are agreements that equalise dividends and set trading ratios for their respective shares. The business may be good but this complex structure is just too difficult for the average person to understand.

WHY WARREN BUFFETT DOES NOT INVEST IN MICROSOFT

As Warren Buffett has said, he knows and admires Bill Gates and the Microsoft Corporation but has never invested in it because he does not understand the way that the company works.

BUSINESS ANALYST PRINCIPLE

BUSINESS ANALYST PRINCIPLE

Value investors do not guess when the market or a stock is at its peak, trough, or specific points in between.

There will nearly always be times when some positions are priced attractively compared to value and others when the opposite is the case.

During periods characterized by bullishness, as the late 1990s, there are fewer value opportunities; during bearish times, as in the early and mid-2000s, there are more.

The universe of prospects enlarges as markets fall and contracts as they rise.

Tendencies in either direction reinforce themselves, as pessimism or optimism spreads.

This requires knowledge of business, accounting, and valuation principles.

Also read: 10 TENETS OF VALUE INVESTING

1. MR. MARKET PRINCIPLE
2. BUSINESS ANALYST PRINCIPLE
3. REASONABLE PRICE PRINCIPLE
4. PATSY PRINCIPLE
5. CIRCLE OF COMPETENCE PRINCIPLE ****
6. MOAT PRINCIPLE
7. MARGIN OF SAFETY PRINCIPLE ****
8. IN-LAW PRINCIPLE
9. ELITISM PRINCIPLE
10. OWNER PRINCIPLE