The key to successful investing is not picking big winners; it is avoiding big losers. Learn from the mistakes. Mistakes are inevitable but every savvy investor should at least try to make original ones. In a lecture at the Stanford Business School on 18-Apr-1990, Warren Buffett said,
The strange thing—it’s a real contradiction—is that if a business is earning a given amount of money and everything else is equal, the less it has in assets, the more it’s worth. You won’t get that in an accounting book. The really desirable business is that one that doesn’t take any money to operate because it’s already proven that money will not enable anyone to get a position within the business. Those are the great businesses.
There can be a fine line between opportunity and trouble when a once-strong business goes into permanent decline. Equity holders won’t benefit if debt levels in a company produce a bankruptcy or a massively dilutive refinancing in the near term.
Investors also tend to fail because they use contemporary experience to deduce ad infinitum into the future what is clearly a one-time growth ramp of a product. People are steadily way too optimistic and undervalue just how competitive the US economy is in these types of things. Fortunes can be made by investing in cyclical businesses if you have a deep consideration of the industry and you’re buying at maximum cynicism.
Two-thirds of all acquisitions are failures and a wide range of accounting shenanigans that can occur when one company acquires another; it’s remarkable how frequently investors get excited about big acquisitions or roll-up stories. Overlook the market, other than to take advantage of its chance mistakes. In the 1998 annual meeting of Berkshire Hathaway’s shareholders, Warren Buffett said,
The business is wonderful if it gives you more and more money every year without putting up anything—or by putting up very little. And we have some businesses like that. A business is also wonderful if it takes money, but where the rate at which you reinvest the money is very satisfactory. The worst business of all is the one that grows a lot, where you’re forced to grow just to stay in the game at all and where you’re reinvesting the capital at a very low rate of return. And sometimes people are in those businesses without knowing it.
Focus on earnings before interest, taxes, depreciation and amortization. There’s a righteous cycle when people have to uphold challenges to their ideas. Any gaps in thinking or analysis become resounding quickly when smart people ask good, rational questions.
Recommended Reading on Warren Buffett & Value Investing
- ‘Berkshire Hathaway Letters to Shareholders ‘ by Warren Buffett, Max Olson
- ‘Warren Buffett Invests Like a Girl: And Why You Should Too’ by Motley Fool, Louann Lofton
- ‘The Oracle Speaks: Warren Buffett In His Own Words’ by David Andrews
- ‘Warren Buffett on Business: Principles from the Sage of Omaha ‘ by Richard J. Connors