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Investing Lessons of 2008: Know What You're Buying

By John Rosevear - Updated Apr 5, 2017 at 7:52PM

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Some "great buys" are better left unbought.

2008 was a crazy year and nobody knows for sure what 2009 will bring. We’ve spent the past month reflecting on 2008 and making predictions for 2009. Be sure to check out all of our coverage, including more Investing Lessons of 2008.

Everybody knows General Electric (NYSE:GE). Light bulbs, jet engines, dishwashers, Thomas Edison, Jack Welch, tradition of greatness, all that stuff ... they're an American icon, as blue-chippy as blue chips get. They bring good things to life.

Have you looked at GE lately? Its stock price has been blasted so badly that the dividend yield is up to almost 8%. Eight percent! That's a no-brainer buy, isn't it?

Well ... it might be a buy. But it's not a no-brainer. One reason GE is cheap right now is thanks to the woes in its financial services division. GE Capital provided about half of the company's profits in 2007, but as with a lot of financial companies, 2008 has been a different story.

Cash infusions from stock and debt sales -- some, famously, placed with Warren Buffett's Berkshire Hathaway (NYSE:BRK-B) -- have helped hold things together, and although S&P has said that the company's AAA rating is at risk, GE is widely expected to muddle through.

But here's the point: Like lots of stocks that look cheap or that sport big dividend yields, GE is cheap for a reason -- and finding its true value right now isn't simple. If you don’t know how to analyze a bank's financials, you're not going to be able to see the full picture at GE -- and if we've learned anything in 2008, it's to be wary of balance sheets we can't understand.

Buffett's endorsement notwithstanding, GE might belong in your "too hard" pile.

Everybody should have a "too hard" pile
Here's a rule I think all investors should take to heart: It's OK if you don't understand a company's business. But if you don't understand it, don't buy it.

The "too hard" pile is the mental filing cabinet for those hard-to-understand businesses -- the ones with opaque balance sheets or major exposure to hard-to-predict factors like exchange rates, or that operate in esoteric technical niches. There's no shame in having such a pile. Even Buffett has one. Sure, he's missed some opportunities over the years, but his results speak for themselves. I think his knack for avoiding disasters is at least as important to his success as his ability to pick winners.

As many investors have learned the hard way this year, big blowups can do big damage to your portfolio. While 80% gains are wonderful, 80% losses are disastrous -- yet we often put too much focus on finding the former while overlooking the possibility of the latter. Having a "too hard" pile helps you remember to evaluate the risks as well as the potential -- and to set the stock aside if the risks aren't clear to you.

If you can't see the risks, they might be bigger than you think
Imagine that it's 2007 and you're trying to get a grip on American International Group (NYSE:AIG). A lot of professionals thought AIG was a pretty good buy around $60 a year ago. I looked at it myself, but it made my brain hurt. Nobody, it seemed, really understood how much "subprime" exposure AIG had. I didn't see a way to figure it out, so it went into my "too hard" pile.

That was one of the best investing decisions I've made. That's hard-won wisdom -- years ago I got burned badly after buying a "hot stock" with a technology I didn't quite understand. But that doesn't mean we have to abandon companies with complex products -- we just have to make sure we understand their business.

Most businesses aren't "too hard"
If you've been to a Starbucks (NASDAQ:SBUX) or McDonald's (NYSE:MCD) store, you know what each company does. There might be hard questions to work through around future growth or financial condition or expansion plans, but it's clear where the money comes from.

The same is often true even with high technology or big, diversified companies. The iPhone is a technological marvel -- but the nuances of the technology aren't essential to figuring out Apple's (NASDAQ:AAPL) business prospects. Johnson & Johnson (NYSE:JNJ) has several different businesses, but it's always clear where the money comes from.

And that's the takeaway: If you can't explain how a company makes money, or you don't understand the dynamics of its industry or what the risks are, set it aside. There are too many good stocks out there, even now, to take the chance of buying the next AIG or Lehman Brothers.

More Foolishness:

Fool contributor John Rosevear owns shares of Apple. Johnson & Johnson is a Motley Fool Income Investor pick. Starbucks and Berkshire Hathaway are Motley Fool Inside Value selections. Starbucks, Berkshire Hathaway, and Apple are Motley Fool Stock Advisor selections. The Fool owns shares of Starbucks and Berkshire Hathaway. Try any of our Foolish newsletters free for 30 days. The Fool's disclosure policy knows what it's holding and when to do its folding, and always avoids scolding.

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Stocks Mentioned

McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$256.80 (-0.94%) $-2.43
Starbucks Corporation Stock Quote
Starbucks Corporation
SBUX
$85.72 (-0.01%) $0.01
Apple Inc. Stock Quote
Apple Inc.
AAPL
$164.87 (-0.29%) $0.48
Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
BRK.B
$292.34 (0.09%) $0.27
American International Group, Inc. Stock Quote
American International Group, Inc.
AIG
$52.27 (0.85%) $0.44
General Electric Company Stock Quote
General Electric Company
GE
$75.18 (1.10%) $0.82
Johnson & Johnson Stock Quote
Johnson & Johnson
JNJ
$170.20 (-0.53%) $0.91

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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