Never Invest in a Business You Don’t Understand
Understanding a company’s value is essential. At conferences, many people ask me what I think about private equity or hedge funds. I always say that you need to know what you are buying and be clear about the company’s value. Some people think investing is very simple, while others find it hard to grasp. For me, raising capital is easy, but understanding a company is difficult. Before putting money into the market, we must first understand the business.
There are many ways to learn and study a company, such as analyzing its financial reports, evaluating its management team, and understanding its corporate culture.
For example, many people love the iPhone. They know that if they want to make money in the market, they could buy Apple’s stock. But how many Apple shareholders have actually read Apple’s financial reports? Many people know it’s a great company, but they don’t understand its financial health. Perhaps it was a good company last year, but if its revenue declines this year, then even if investors bought shares last year, they might lose money next year—even if the public still calls it a good company and many people still love its products.
A lot of people know how much an iPhone sells for, but very few know how much it costs to make one. Investors must understand a company in depth, ensuring they know how it makes money and how profitable it really is.
In my December finance conference speech, I emphasized repeatedly that investors should know exactly what they own. You cannot make money without understanding the business. If you don’t even know the basic facts about the company, you are not an investor—you are a speculator. Too many people blindly invest in the stock market without knowing how a company generates revenue, manages its expenses, or creates profits. Only investors who truly understand a company’s economic operations can make money. This is exactly what Warren Buffett calls an “intelligent investor.”
Moreover, investors should also understand a company’s history. The phrase “This time is different” has cost many stock market investors far more than they realize. Yes, every era has its differences, but we can still learn valuable lessons from history to guide today’s investment decisions. If you don’t learn from others’ failures, you could suffer serious losses to your wealth.
History can tell you whether a company is trustworthy and whether it has delivered on its promises. For example, if a company promised five years ago to achieve a certain goal but has yet to meet it, the probability of failure this time is still high. Human behavior and thinking often repeat in many ways, which is why economic cycles continue to recur.
The financial market is essentially the collective thinking and behavior of millions of people reflected in price charts. You can take advantage of this collective psychology. Many people think “this time is different,” but in reality, the system contains many similarities—such as fear and greed. Therefore, in investing, understanding the business is of utmost importance.
Here are some questions investors can ask themselves to better understand a company:
Is this business simple and easy to understand?
Does the company have good long-term prospects?
Does the company have serious debt problems?
Is the company’s operating history stable?
Does management’s interest align with shareholders’ interests?
What is the company’s return on equity (ROE)?
We can study a company from multiple perspectives—its business model, its management, and its financials—to gain a more comprehensive understanding.
