Buffettology: Buy Businesses That Can Be Run by Idiots.
"I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will." This quote was inspired by Peter Lynch and regarded as such a great quote by Warren Buffet that he decided to live by it as if it’s his own.
Unfortunately not all people can make lemonade when life hands them lemons. A management team has the power to create and manage pioneering companies, but at the same time mismanaging a company can destroy it.
Although we invest in great companies with strong management teams, we cannot predict the future. Sooner or later those great companies might be run by idiots – a worrisome thought at the back of every investor’s mind. The best way to approach this problem is to stick to your investment strategy by only buying wonderful companies in industries you have deep knowledge of.
Warren Buffett is famously known to dislike technology stocks and startups. The companies he favours offers basic services or products such as razors, batteries, laundry detergent, soft drinks, auto insurance, etc. The reason? So that one day when an idiot takes over the company, the business won’t crash and burn.
How to Buffer Your Investment Portfolio Against a Fool
1. Buy Stocks in Industries You Understand
One of Warren Buffett’s investing tips is that you should only invest in what you know. He prefers investing in basic services and products, because they are industries that he understands.
It is vital to only invest in sectors you have knowledge of. Understanding the fundamentals of the company and the way in which it works gives you better insight with regards to the strength of a company. You should buy into business that can be run by anyone, because the possibility of an idiot running the company in the future can’t be ignored. There is no place for naivety in investing.
Buffett knows he doesn’t have enough knowledge of the technological sector that is why he doesn’t invest in the industry. You can’t go wrong with investing in a business that is simple and easy to run.
2. Fundamentally Analyse a Company
This is the process where you separate the wheat from the chaff. By fundamentally analysing a company you can determine its intrinsic value, strength, forecasted earnings, potential growth and if it is a buy or not. These metrics can be compared to one another to find the value-bargain you are looking for. Remember you are searching for companies with low debt, a lot of free cash and good forecasted earnings or growth potential. Combining the latter will give you a clear picture of the strength of a company.
3. Only Buy Healthy Businesses
Construct your portfolio out of healthy, sound companies. The stronger the company, the better the chance of it continuing at the same rate as before, even though it might be under new management.
Fundamentally sound companies run by themselves. If you deliver a good product or service your company will keep doing well. For instance, if we take a look at Apple. Steve Jobs was the visionary behind Apple with a clear goal of creating a pioneering conglomerate in which he succeeded. When he passed away the torch was handed over to Tim Cook, which in my opinion is no Jobs. Even though the proverbial ‘CEO-torch’ was passed, Apple is still going strong thanks to its sound fundamentals.
4. Invest with a Margin of Safety
Investing with a margin of safety means buying equities trading significantly below their intrinsic value. The difference between the estimated intrinsic value and the trading price is referred to as the margin of safety. By purchasing equity trading at significantly cheap prices, you lower the volatility of your portfolio. If your stock purchases do eventually fail due to mismanagement you might not lose as much money, because you invested with a margin for error. It also gives you time to realise your mistake and opt out as shareholder, before the company declares bankruptcy. It is better to be safe than sorry.
Don't put all of your eggs in one basket. Diversifying your portfolio lowers the level of portfolio risk, by spreading your investments over a variety of companies, sectors, markets and currencies. You should still only invest in companies and sectors that you have a good understanding of, but instead of holding one company you should own multiple companies in a variety of industries. If for instance your portfolio consists of one company's equity and it gets taken over by a fool causing the company to fail, you will lose all the money you have invested. If your investment portfolio is diversified, you may still lose some money from investing in that company, but the rest of your investments will carry you through the dark times and give you the opportunity to recover from your losses.
If you combine and apply these five tips to your investment strategy you will only buy wonderful, fundamentally sound companies that will serve as a buffer against mismanagement, making your portfolio idiot-proof.