Warren Buffett’s company Berkshire Hathaway is one of the world’s largest holdings companies. At the time of writing, it has more than 60 subsidiaries that it owns across a dozen industries, and even more in which it holds a minority or even majority stake. With all of those businesses, it can be a wonder that Buffett is able to keep track of it all.
As it turns out, however, Buffett has a very simple strategy when it comes to choosing new companies to purchase or invest. And, as you might expect, it is based all on the idea of sticking with what you know. We often refer to this as a circle of competence.
According to Buffett, the best way to select a new investment opportunity (be it acquisition or not) is to stick with businesses and industries with which you’re already familiar. Sometimes, investing more in something is a better bet than risking a new company entirely.
“Before looking at new investments, we consider adding to old ones. If a business is attractive enough to buy once, it may well pay to repeat the process,” Buffett wrote in his 1994 letter to shareholders. “…I find that a long-term familiarity with a company and its products is often helpful in evaluating it.”
However, more than that, this concept can be applied to looking for new investments. After all, once you own a company and understand its operations, then you’re better able to judge within that industry whether other companies are doing well. This is something Buffett and Berkshire do frequently.
In fact, if you look at the list of companies owned by Berkshire, you’ll start to see some pretty obvious patterns. While there are a few outliers, many of his businesses are either in insurance, manufacturing, or energy. This way, Buffett is able to not only make more informed decisions, but also build his knowledge to the point where he can branch out. For example, once Buffett got a handle on how the insurance business worked, he began investing in reinsurance companies, which are kind of similar.
It might seem counter-intuitive at first, but sticking with what you know is sometimes an even better idea than diversifying–provided you have all the right information.
“Diversification is protection against ignorance. It makes little sense if you know what you are doing,” Buffett said.