During the height of his career, Albert Einstein was in the middle of listening to his secretary dictate his notes to him when he stopped and asked her, "Did I really write that? I could have put that so much simpler."
Just as Einstein was able to simplify even the most complex concepts, the world's top investors have a knack for focusing on the two or three big factors that lead to a successful investment and ignoring the meaningless noise of millions of other factors.
So many numbers, so little comprehension
It's easy to get lost in the complex world of investing. There are so many things you can pay attention to: quarterly earnings releases, economic forecasts, stock price movements, interest rate changes, buyout rumors, and more. You could spend all day focusing on the nitty-gritty details ... and quickly drive yourself nuts.
Yet some of the world's greatest investors have achieved success with ideas that are as simple as pumpkin pie. Late last year in an interview on Fox Business Channel, Warren Buffett explained how he spends most of his day: "I've got something that's fairly simple that works for me. And that's to sit down and look at hundreds of companies and try to figure out if a company is worth X and [if] I can buy it at half of X in the market."
That's it. No mind-bending formulas, no complicated market timing, no tick-by-tick news updates. Sounds to me like a formula for less stress and, possibly, lots of money. Let's see how it's done.
Success is simple
Peter Lynch once recommended that investors have a simple investment thesis, called the two-minute drill. The idea was that if you couldn't summarize in just a few sentences why you're investing in a company, you're probably looking at too much information. You should be able to say something like this: "I'm investing in X because it's the industry leader and it's selling for eight times earnings. It owns 50% of company Z, which contributes 90% of the market cap, so I'm getting all the rest of the business for just 10% of the total market cap, and that business generates Y profit each year."
You might have 20 more pages of detailed due diligence, but boiling it down like that helps you focus on the important stuff.
Profiting from simplicity
Here's an example. Back in 2003, hedge-fund manager Mohnish Pabrai began purchasing shares in oil-tanker company Frontline
While other investors were worried about the future price of oil would -- a key determinant in oil-tanker pricing -- Pabrai took a simplified view and focused his attention on a clear-as-day factor that others largely ignored.
His two-minute drill might have read something like this: "Here's a company that has to charge a large dayrate, which at the moment is difficult, but the scrap metal value of the tankers is worth significantly more than the current price of the stock. If oil prices come back up, and Frontline can survive until then, this company, currently selling for less than the scrap value of its assets, should be a good investment -- and at worst, we'll get a smaller return if the company does have to scrap things."
Pabrai wasn't certain about the future price of oil. He didn't know where shipping rates were heading in the near future. What he did know was quite simple: Regardless of unknown factors, Frontline was undoubtedly worth more than the share price, based on scrap-metal value alone. Investors who kept their perspective this simple ended up making as much as 20 times their money in two years. Simplicity at its finest.
The master in two minutes
Last year, Buffett gobbled up railroad stocks such as Burlington Northern
Nobody can get a handle on every variable that surrounds a company. Fortunately, you don't have to. Focus on the few important factors that will lead to a successful investment, and ignore the rest. The more complicated your investment idea is, the more likely that it will fail to come true. Keep it simple, Fool!
For more simple Foolishness:
- A Simple Lesson From Buffett
- Warren Buffett Is a Better Investor Than You
- Not Listening to Buffett Cost Me Thousands
On May 2, advisors Bill Mann, Seth Jayson, and Philip Durell head to Omaha, Neb., to represent you at the 43rd annual Berkshire Hathaway annual meeting. Be the first to hear their expert take on each day's events, including Warren Buffett's outlook on his favorite industries, companies, and the U.S. economy. Simply sign up below. It's free and there's no obligation.
This article was originally published on Nov. 1, 2007, and has been updated.
The Motley Fool owns shares of Berkshire Hathaway, which has also been recommended to subscribers of our Motley Fool Inside Value and Motley Fool Stock Advisor services. You can try either one out absolutely free for 30 days.