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
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
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
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
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
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.