One of the key drivers behind Warren Buffett (Trades, Portfolio)'s success over the past seven decades has been his foresight to get into the right industries at the right time.
Although he has made some mistakes along the way, his decisions to build a strong insurance business, invest in the consumer goods sector through companies like Coca-Cola (KO, Financial) and American Express (AXP, Financial) and pivot into technology with the purchase of Apple (AAPL, Financial) were all well-timed.
His decision to build an insurance business was particularly interesting because it helped build the foundations for the Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) that exists today.
Buffett's approach to finding companies
In 2015, at the annual meeting of Berkshire investors, a shareholder asked the Oracle of Omaha why he decided to get into the insurance industry in the first place. The shareholder wanted to know if any particular traits drew the investor to the sector over all the others when he started acquiring insurance companies in the 1960s.
Buffett started his reply by saying that he didn't have a particular plan at the time when he started buying companies. However, he was attracted to different companies when he thought he could understand how they would develop and grow over the next 15 years:
"But we basically looked for companies where we thought we could understand what the future would look like 5 or 10 or 15 years hence. And that didn't mean we had to do it to four decimal places or anything of the sort, but we had to have a feel for it, and we had to know our limitations. So we stayed away from a lot of things."
He went on to add that there were no planning sessions or strategic investment allocations at Berkshire in the early days. Instead, he just "kept reading," and analyzing ideas "that came along."
In the early days, Buffett was also dealing with a very limited amount of capital, so he had to make tough decisions when it came to comparing different investments.
The challenge was analyzing one business against another and figuring out which would provide the best return for investors. The solution was to lean "toward things where we felt we were certain to get a decent result than where we were hopeful of getting a brilliant result."
By using this simple strategy and putting "one foot in front of the other," Buffett was able to build the foundations of Berkshire and develop the organization into the investment giant it is today.
What is really interesting about this whole strategy is that it is not particularly complex or challenging to understand. Buffett only wanted to buy investments he knew, and that was the biggest hurdle he had to overcome before he purchased an equity or business for his portfolio.
The key to this investment puzzle was for Buffett to understand how a business made money and if it could continue to make money for the foreseeable future. Without this critical data point, he would not advance on the opportunity.
This is a simple strategy, but it could also be challenging for investors to follow because it requires a considerable amount of discipline. Staying away from potential investments that might seem attractive, but are challenging to understand, is tough - something this author knows all too well.
It is very tempting to try and estimate forecasts and rely on profit projections to have a guess at how a company may perform over the next few years. This approach will only add more uncertainty to the equation. If one is using estimated figures to come up with an estimated valuation, how reliable is that number?
This simple mind trick has formed the foundations of Buffett's success over the past 70 years.
