In addition to his impressive pile of wealth and wisdom, Warren Buffett is famously known for avoiding investments in industries he does not completely understand. The Berkshire Hathaway (NYSE:BRKA) CEO has managed to avoid peer pressure and the desire to find the next hot stock by simply investing in his circle of competence — a crucial lesson all investors should keep in mind.
Buffett seeks to invest in companies that have a significant amount of certainty. This makes it easier to predict future earnings and the value of a business. By sticking to what he understands best, Buffett reduces his risk by not having to rely on the opinions of others. “We are searching for operations that we believe are virtually certain to possess enormous competitive strength ten or twenty years from now,” Buffett wrote in his 1996 letter to shareholders. “A fast-changing industry environment may offer the chance for huge wins, but it precludes the certainty we seek.”
Buffett adds: “I should emphasize that, as citizens, Charlie and I welcome change: Fresh ideas, new products, innovative processes and the like cause our country’s standard of living to rise, and that’s clearly good. As investors, however, our reaction to a fermenting industry is much like our attitude toward space exploration: We applaud the endeavor but prefer to skip the ride.”