Business and investing are unpredictable sports. For every single investment or business decision, there are a range of different options to consider. All of these are likely to have a different outcome, which may or may not be favorable for the decision-maker.
The problem is, outcomes are not knowable. For example, we have no idea if the company we have just invested in will manage to complete its growth goals in the time set out by management. We also have no idea how the market or other investors will react to the eventual outcome.
Separating what we do know and what we don't is challenging but vital to the process of investing. It is impossible to know everything there is to know about any business before you invest. However, there will always be unknowns that are unquantifiable.
Known unknowns
According to Warren Buffett (Trades, Portfolio), a crucial part of successful investing is to define what is not knowable and stay away. At the same time, some things are knowable but not necessary, and it's best not to "clutter up" your mind with these irrelevant points.
At the 1998 Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) annual meeting of shareholders, Buffett said that rather than focusing on what he does not know and the things that he will never have any chance of understanding, he likes to "think about things that are important and things that are knowable."
He went on to say, "there are all kinds of important subjects that Charlie and I, we don't know anything about, and therefore we don't think about them."
So, rather than spending his time trying to understand the future prospects for an industry he has no experience in, Buffett likes to avoid these problematic questions altogether.
Instead, according to the comments he made in 1998, the value investor sticks to the areas of the market that he knows — areas where there is a high probability that he can predict the future with an above-average accuracy rating:
"We do think we know something about what Coca-Cola's going to look like in ten years, or what Gillette's going to look like in ten years, or what Disney's going to look like in ten years, or what some of our operating subsidiaries are going to look like in ten years. We care a lot about that. We think a lot about that. We want to be right about that. If we're right about that, the other things get to be — you know, they're less important. And if we started focusing on those, we would miss a lot of big things."
But investors should also have a degree of ignorance according to Buffett:
"I've used this example before, but Coca-Cola went public in, I think, it was 1919. And the first year one share cost $40. The first year it went down a little over 50 percent. At the end of the year, it was down to $19. There were some problems with bottler contracts. There's problems with sugar. Various kinds of problems. If you'd had perfect foresight, you would have seen the world's greatest depression staring you in the face, when the social order even got questioned. You would have seen World War II. You would have seen atomic bombs and hydrogen bombs. You would have seen all kinds of things. And you could always find a reason to postpone why you should buy that share of Coca-Cola. But the important thing wasn't to see that. The important thing was to see they were going to be selling a billion eight-ounce servings of beverages a day this year. Or some large number."
The bottom line
This might seem like contradictory advice. After all, most investors believe that buying a stock with a mixed outlook is a bad decision. But with an ultra-long-term view, Buffett's advice makes a lot of sense.
We can't tell what's going to happen to the market or economy over the next five, ten or tweny years. Nevertheless, it is highly probable that some companies will be larger several decades from now than they are today. Those are the important and knowable factors.
Disclosure: The author owns shares in Berkshire Hathaway.
Read more here:
- How to Learn Investing, Accoridng to Warren Buffett and Benjamin Graham
- When Is the Best Time to Sell a Stock?
- Warren Buffett's Advice on Choosing an Index Fund
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
