Investing is a tricky business. It involves strategy, foresight, and even hindsight. A lot of people look to Warren Buffett for advice, and he freely offers it. He runs one of the most successful conglomerates in the world, plus, he’s got some strategies that are pretty easily followed— like these three types of companies that Buffett avoids making investments in.
1) Young Companies
With any new and hot companies on the rise, there is a lot of risk involved. Most of the risk probably just comes from a lack of statistics and information— there isn’t a lot here for Buffett to analyze. Some good examples of this are Netflix and GrubHub; While there is a lot of potential for these companies they just don’t have a lot of consistent profit, which is something Buffett always looks for.
Another issue with young companies is management. Buffett is known for saying he doesn’t like to invest in companies whose success is “based on the smartness of its people.” Instead, he likes to look for operating processes, product creations, and business models. The fact is, though, that young companies are still very dependent on a few personalities— namely the CEO and founders.
2) High-Capital, Low-Profit Companies
“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little to no money,” Buffett said in his 2007 shareholder letter. And, really, this one is pretty obvious.
In the letter, Buffet expands on this idea using airlines as an example. Since 1998, Buffett’s portfolio had been lacking any airlines as he almost suffered a large loss. This year, however, Buffett took out a stake in each of the four major U.S. airlines. Though it is unclear why, it could be because the companies are pretty set with start up capital and now can focus on being profitable. Also, the airline stock that Buffett bought up accounts for only about 1% of Berkshires total holdings, so there isn’t too much risk here. It just goes to show that even Buffett can change his mind!
Some industry examples of this include hospitality and electronic companies. You need a lot of money to start a hotel or phone company, and it’s going to take a while for you to start seeing a profit. Buffett doesn’t like that; he is a busy man. Instead, Buffett looks for companies that he will not need to mentor and guide, and instead can just offer financial support.
3) “Tech Companies”
People tend to speculate that Buffett openly avoids technology companies, but with large stakes in IBM and Apple that just isn’t true. Rather, Buffet doesn’t invest in stocks that he simply doesn’t understand.
“You don’t have to be an expert on every company, or even many,” Buffett said in his 1996 shareholder letter, “You only have to be able to evaluate the companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
By focusing on companies that you’re sure you can understand, you lower a lot of risk. It’s important to not spread yourself too thin!