There are tons of companies out there. Some of them sell candy, while others sell the most advanced technological devices ever constructed by humankind. Other ones sell complex services with a hard-to-grasp and possibly uncharted business model. In order to be successful investors, we must acknowledge that there are some types of companies that we understand, and some that we do not, and then we must only invest in what we understand. Investing in dividend stocks we don’t really grasp is speculation.
Warren Buffett is a prime example of this. The man made his fortune investing in things like banks, oil, food, car insurance, soda, and razors. You don’t have to predict the next multi-billion-dollar tech ascension to perform well with your investments. Instead, you just have to identify well-run, growing companies with reasonable valuations that you understand. You need to understand the business model and the various risks and opportunities that the company has, as well as the financial side of their business. If you can do that, you can make educated predictions derived from quantitative facts and qualitative opinions about the company.
So sometimes I’m curious why I see people that don’t know much about a given industry investing in that industry. I’m not saying we all have to be gurus of a variety of industries, but we do need to understand the businesses at least. Few people understand how Intel makes what they make. Few people can predict in exactly what form cloud computing is going to take off, and who is going to prosper from it the most. Few people grasp new and risky medical companies or high-flying tech upstarts. Before investing in these companies, make sure you really “get” them and be honest with yourself.
Sure, there are some blue-chip companies that have some complex products. They’re also diverse and mature, though. They have a steadier place in the economy and offer a variety of products and services of various levels of complexity, and often wield huge patent shields. But many other companies don’t have those luxuries, and to invest in companies that you don’t have an understanding of boosts your risks.
I’ll use myself as an example, so take a look at my portfolio. You’ll find companies that make cooking appliances, blue-chip dividend-paying healthcare companies, infrastructure companies, food companies, insurance companies, consumer products companies, and one mature technical conglomerate. My primary profession is that of an engineer, and yet you don’t see a collection of fancy tech companies. Why? Because I find it difficult to gauge the viability of a tech company 5 years down the line, which is my minimum investing horizon. Sure, I have a fair technical understanding, but that doesn’t mean I can accurately predict which technology is going to catch on, what clutch patents are currently held, and how industry trends will favor one tech upstart over another. Technology moves at a rapid rate, and companies can become threatened or obsolete very quickly. On the other hand, things like peanut butter and jelly, gas pipelines, shaving cream, property insurance, and baby powder aren’t going anywhere anytime soon.
This is more relevant now than ever. I don’t know about you, but I’m becoming increasingly interested in the low valuations of some tech companies like Intel, Microsoft, and Texas Instruments, which I’ve been following for quite a while. If investors decide to invest in tech, make sure you really do your homework, and for the most part try to spread out your risk and focus on shareholder-friendly, value-priced, mature businesses.
Banks are another example. The fact that so many bank investors had their dividends cut and fortunes lost is a testament to how little most people truly know. Many economists and professional portfolio managers totally missed the signs of a collapse. The trillions of dollars of derivatives on huge bank balance sheets hidden behind obscure accounting standards were just too much for most people to grasp. Conservative banks make more reasonable investments than others, but make sure you do your homework.
If you’re an expert in a given industry, then leverage that to your advantage. If not, stick to what you know and what is straightforward. Constantly expand your knowledge, but be realistic with your investment choices by identifying what you do and do not know. Investing is never easy, and every company has complex elements to it, but it helps to at least stack the deck in your favor by focusing on companies that you feel you can realistically grasp.