When investing, knowing what not to do can be every bit as important as knowing what you should do. Warren Buffett knows this well, and much of his success over the years can be attributed to things he avoids doing. In the aftermath of the financial crisis, Buffett shared four of these things with Berkshire Hathaway's (BRK.A -0.15%) (BRK.B -0.17%) shareholders, and there is valuable investing wisdom to be found in each one.
He doesn't invest in businesses whose futures we can't evaluate
No matter how exciting a business or industry may be, if Warren Buffett and co. can't analyze its future, they won't be investing in it.
This is the main reason why Buffett stays away from tech stocks -- it's simply too difficult to evaluate the future of any single company. Sure, it's prevented him from pursuing potential home-run investments like buying Microsoft in the 80s, but it also helped Berkshire largely avoid the tech bubble.
Buffett points out three industries that obviously had massive potential: automobiles in the early 20th century, aircraft around 1930, and televisions around 1950. Getting in on the ground floor of any of these could have been great, if you had picked one of the winning companies. The odds are simply stacked against investors in the early days of high-potential businesses.
In the automobile industry, General Motors, Ford, and Chrysler survived, but thousands of other manufactures weren't so lucky. For example, the Stutz Motor Company, which is attributed with inventing the "sports car" and at one time produced the country's fastest production car, didn't survive the Great Depression -- and there were many other companies in the same boat.
The point is that you should stick to companies with reasonably predictable futures. Long-established companies with stable financial footing and strong brands, like Coca-Cola or Procter & Gamble (two Buffett stocks), are the better way to go.
He doesn't depend on the kindness of strangers
Buffett will never count on Berkshire being "too big to fail." The company will always have more than enough cash on hand to take care of any potential capital needs that may arise. In fact, at any given moment, Berkshire has a stockpile of at least $20 billion, and generally this is much more.
When the financial crisis hit, Berkshire wasn't among the companies with its hand out. Rather, it used its superior capital position to supply liquidity to companies in need, and made some pretty impressive profits in the process.
Although it happened a couple years after Buffett wrote this letter, Berkshire's investment in Bank of America is an excellent example of how beneficial this is. In exchange for buying $5 billion in Bank of America preferred stock, Buffett also received warrants to buy 700 million shares of the bank's stock for $7.14 per share. Well, not even five years later, the bank has done a great job of risk management and building a sustainable business, and the value of this investment is more than $10 billion, an annualized return of more than 15%.
He won't have too much management
As of this writing, Berkshire Hathaway has 62 subsidiary companies listed on its website with more than 360,000 employees worldwide. And, Berkshire manages this empire with a staff of just 25 employees at its home office.
One of the main reasons Buffett acquires the companies he does in the first place is because they already have excellent management in place. Therefore, he figures it would be silly to mess up a good thing, and gives his managers the freedom to operate each company as they see fit – a strategy which has paid off in most cases.
The last thing Buffett wants is for Berkshire to evolve into a company with multiple layers of management and committees. Rather, Berkshire's companies will remain independently managed, and the extent of the central office's involvement will mainly be to allocate capital and support the managers.
What can you possibly learn from this as an individual investor? Simply put, you should focus on companies with simple management structures whose long-term success and failure doesn't depend on any one person who happens to be calling the shots at the moment. Coca-Cola (a longtime Buffett stock) is a great example -- its distribution network and valuable brand portfolio makes it so the company could nearly run itself. In fact, Buffett has said that a "ham sandwich" could run Coca-Cola.
He won't attempt to woo Wall Street
Finally, while many companies spend lots of time trying to convince analysts and the media that they're company is a strong investment, Buffett has no interest in doing this. Rather, it is a priority for Berkshire to focus on communicating directly with shareholders.
Berkshire strives to keep its business as transparent and easy-to-understand as possible. Shareholders buy the stock because they believe in Berkshire's businesses and the ability of management to provide those businesses with the tools they need to succeed.
The takeaway here is that it's generally a bad idea to invest in a business you don't fully understand, simply based on analyst or media recommendations. As a personal example, there are some biotech companies that are highly recommended by analysts right now, and I'm sure some of these do indeed have a bright future. However, I really don't understand that business well, so I tend to gravitate instead toward areas of the market I have a firm grasp on like, banking, energy, and real estate. Within those industries, I look for companies with shareholder-friendly managers, a strong balance sheet, and prudent risk management.
The Foolish bottom line
Although Buffett originally said all of these things in the midst of a volatile post-crisis market, they still apply in both good times and bad. Stick to businesses with products or services will be needed for decades to come, invest in easy-to-run businesses that you understand, and make sure the companies have adequate liquidity for whatever the economy brings. If you do this, you'll be well on your way to creating a Buffett-esque stock portfolio of your own.