Warren Buffett likes to invest in companies where management focuses on activities that are within the expertise of the company and not wander off and spend shareholders’ money in going into areas that they know little about.
Keeping a company on track is obviously an attribute of sound company management and is a sound investment principle.
Understanding the business
This is really just an extension of Warren Buffett’s investment principle that one should not invest in a company whose business one does not understand. If it applies to direct investment, it also applies to indirect investment and an investor is better off investing in a company that uses its capital in areas of its own expertise.
A good example of a company sticking to what it knows is Coca Cola. So far as we can ascertain, Coca Cola sticks to its long standing core business of manufacturing and selling carbonated and associated drinks and syrups and licensing its name and its products to other companies in other countries. A look through the Coca Cola products list does not indicate any products that are outside its area of knowledge.
Companies that didn’t stick to what they knew
There are many examples of highly successful companies getting involved in business areas that they know little or nothing about, either by acquisition or by opening new divisions within their company and coming a cropper. We need only mention a few recent examples:
- Mattel, the toy experts, paying big money for The Learning Company, an educational and entertainment software company (Where in the World is Carmen Sandiego?)
- E-Bay, online auctioneers extraordinary, paying too much for Skype, rescued by Microsoft taking it off their hands (the jury is still out on this one)
- The disastrous merger between Time Warner and AOL, two companies with expertise in their own business but not much in the other’s.