Warren Buffett (Trades, Portfolio) is the world's most significant investor, and it would be easy for him, being in this position, to think that he knows everything.
But that couldn't be further from the truth. Even though Buffett is is in the position he is today, he is acutely aware that he does not know everything. He works hard to factor this into his decisions.
Forecasting the future
In the past, the Oracle of Omaha has said that he is only looking for stocks that are "inevitable."
These so-called "inevitables" are companies like American Express and Coca-Cola, the type of business you know will be bigger 10 years from now thanks to their economies of scale, position in the market and experienced management.
As well as these "inevitables," Buffett also looks only at companies he believes will be larger 10 years in the future than they are today. This means concentrating on businesses where he knows and understands the company and its industry. But for him, that's far more important than finding the hottest growth stocks on the market at the moment. He's not trying to predict each company's growth down to the last 0.1%, or indeed predict growth at all. Instead, Buffett is just looking for companies that will be bigger in 10 years than they are today.
This method of evaluation hasn't changed for decades, and it remains at the core of Buffett's investment process.
The same process
It has become particularly important in recent years as Buffett has started to invest outside of his traditional circle of competence. I'm talking here about his investments in tech companies like IBM and Apple.
In researching these companies, he followed the same process that he did five decades ago when he first moved away from deep value investing and started to bolt on businesses to the textile business of Berkshire Hathaway. Explaining the process he used to evaluate potential investments at the time, at the 2015 annual meeting of Berkshire shareholders Buffett explained:
"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 explain:
"But it wasn't — they weren't elaborate — well, there were no planning sessions or anything of the sort. We just kept reading and we kept thinking and we kept looking at things that came along, as Charlie described it in the movie, and you know, comparing Opportunity A with Opportunity B."
At the end of the process, it all came down to deciding which opportunity had the best prospects:
"And we probably leaned very much toward things where we felt we were certain to get a decent result than where we were hopeful of getting a brilliant result."
This is not a particularly rigorous or involved process (or at least it doesn't sound like it), but it does require a huge amount of time and effort to build out your own circle of competence to a level where you are able to make judgments like these based on the knowledge you have available.
Buffett doesn't rely on spreadsheets of complicated calculations to drive his investment process; he just uses what he knows and calculates the possibility of a positive result over the long term. This is an extremely simplified definition of a strategy, but it really gets to the point of the matter: Investing does not have to be complicated as long as you have a good understanding of the sectors and industries you are investing in.
Disclosure: The author owns shares in Berkshire Hathaway.
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