Going through the old archives of Warren Buffett (Trades, Portfolio) articles and speeches always uncovers some interesting nuggets of information from the Oracle of Omaha. The latest of these nuggets I've discovered is an old question-and-answer session Buffett had with University of Nebraska-Lincoln students in 1994.
The Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) CEO gave this talk shortly after he became involved with investment bank Solomon Brothers, and a large part of the conversation revolved around this investment.
The session also brought up some other interesting topics for conversation, however, including Buffett's view on common sense.
Specifically, a student asked Buffett what would he teach in a class devoted to common sense. Buffett said he was not sure common sense could be taught, then added:
" I do find it amazing how many people with high IQs get off the track. It's astounding to me how people who are really very smart manage to engage in so many self-destructive actions, and I'm not just thinking in terms of business. I have no real prescription, as I look around at the people whom I think are extremely sensible. I don't know quite how to transplant that or teach that to other people. I think a lot of people make things more complicated than they need to."
He went on to say that overcomplication is possibly one of the biggest reasons why investors (and other business owners) struggle to achieve good results.
In Buffett's opinion, the best way to invest is to construct a simple, easy to understand investment thesis, one that can fit on just one side of paper. If you can't do that, then perhaps you shouldn't be buying the stock:
"There is nothing complicated about the way we invest. It is very understandable. I've felt that before people buy a stock, they should take a piece of paper and simply write 'I'm buying General Motors (GM, Financial) at 47,' or 'I'm buying US Steel (X, Financial) at 83.'They should just write out what their reasoning is, and they should be able to get it all on one side of one piece of paper. In fact, they should be able to get it into a paragraph."
It is not only investors that can benefit from using this simple strategy. Buffett goes on to highlight two businesses owners that had tremendous success by using simple business models:
"Almost all of the big, great ideas in business are very simple. Sam Walton's idea was very simple at Walmart (WMT, Financial). It's not hard to do. If you want to accomplish something, and this ties in a little bit with common sense maybe, you have to have focus. Mrs. B had focus. Mrs. B never went to school a day in her life, and she ran rings around all kinds of people because she's smart and energetic. She was also focused."
One thing I should note here is that "simple" should not be confused with easy. It all comes back to your circle of competence. If you know and understand an industry, constructing an investment case should be simple and straightforward. If you don't, a simple investment thesis could be a recipe for disaster -- you will end up cutting corners or investing in something you might not understand.
Buffett has always avoided companies that fall outside of his circle of competence, even if it might mean missing a multibillion-dollar opportunity. Sure, if he tried to understand these opportunities he might be a lot richer today, but he might also be poorer. Spending time trying to understand new sectors might result in him missing something closer to home.
What's the takeaway from all of this? It's simple; if you understand something and can easily see the opportunity, it could be a good investment. If you need to spend time and effort figuring out what's going on, staying away might be the best option.
Disclosure: The author owns shares of Berkshire Hathaway.
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