Learn to invest with Buffett

Chapter 5

Chapter 1 Section 4 Simplicity is the last word
Overly complex financial derivatives, such as CDOs, were one of the causes of the financial crisis.Munger and I have said that these financial institutions have made business operations so complicated that neither government regulators nor accounting standards can prevent these financial institutions from taking such large risks.This lack of control has had disastrous consequences, such as the collapse of Bear Stearns, and is likely to bring more losses to the financial industry.

--Warren Buffett
Buffett believes that the simpler and easier to understand the business of a company, the better.A business that is too complex is prone to unpredictable dangers.

The 2008 financial crisis caused losses of more than US$3000 billion to financial institutions around the world.But Buffett believes that such losses are largely attributable to the financial institutions themselves.In the past, financial institutions have issued many overly complex financial derivative products.For a product like a CDO, if investors want to understand its business content, they need to read at least a 75-word report. Such a complex product greatly increases the risk factor of financial institutions.But because they were too complex, government regulators and accounting standards could not monitor these risks, which led to the full-blown financial crisis.

Buffett said that in Berkshire, this kind of thing is absolutely not allowed to happen.In order to avoid risks, Buffett will not choose particularly complicated businesses when choosing investment companies.Buffett mentioned that he once read a business report of a financial company.This report mainly introduces the operation process of this financial institution to government departments and ordinary investors.But the report runs to 270 pages.As he read, Buffett made a list of what he thought was in doubt on a blank sheet of paper.After reading the last page, Buffett found that he had listed 25 pages of questions.In the end, he really lost his patience, threw away the pen, and decided not to invest in this stock again.The reason why Buffett does not touch high technology is also because he thinks high technology is too complicated and the investment risk is too great.

Buffett believes that if there are many uncertain factors in a certain business, the success rate of investment in this business will be very low.If a certain business has only one uncertainty factor, and the success probability of this factor is as high as 1%, then the investment success rate of this business is 80%; if this business has two uncertain factors, and each factor If the probability of success is 80%, then the investment success rate of this business is 2%; by analogy, the more uncertain factors, the lower the investment success rate of this business.Buffett feels that if the investment success rate of a certain business is very low, even if the business has a high return on investment, he will not invest.

In 1998, Berkshire Corporation planned to invest in a zinc metal recovery project. The content of the project was to extract zinc from the brine produced by geothermal power generation for recycling.Originally, this was a project that Buffett was very optimistic about, with high profit margins and simple project content.However, in the process of actual implementation, problems emerge one after another, and one problem always appears after another.Often just after solving this problem, a new problem pops up.This made Buffett very dissatisfied.After comprehensively weighing the pros and cons, Buffett finally felt that the investment success rate was too low, so he gave up this very profitable project.

Investment motto:

If the business of the enterprise is too complicated, the risk of enterprise operation will be relatively large.Moreover, it is not easy for investors to understand a business that is too complicated.Therefore, investors try to stay away from companies with complex operations.

(End of this chapter)