I recently told you on the blog about one of the key concepts of value investing, the circle of competition. Today I bring you a concept closely related to this one, which became popular thanks to circle of competition and its importance. If we decide to analyze complicated companies, we will have to invest more time and it will be much easier for us to make mistakes. Therefore, my recommendation is to only include in our circle of competence companies that offer us a potential profitability that is worth it in relation to its complexity.
Again, this will depend on the individual investor. For example, I invest companies in the technology sector without difficulty, since I have always been interested in the world of technology. However, other people may find the world of technology too complex, so the "brain damage" will be greater.
Why didn't Bill Ackman invest in HP?
Although HP might appear to be trading at a good price to Ackman, he decided not to invest time or resources in analyzing the company. Why? Because of the complexity that its analysis would imply. Ackman relied on the following:
- The future of the personal computer industry is very difficult to predict.
- There is a very high competitiveness.
- He did not know the direction the business would take.
Bill Ackman's approach, like that of most followers of the value investing, is to find companies in which one can be able to predict how they will behave (with some precision) over a long period of time after an analysis process.
At the time of these statements, HP shares were trading at just over $ 23 per share. They are currently trading at around $ 12 per share, although they fell below $ 6 per share. Therefore, it seems that in the end time ended up proving Ackman was right.
Now is your turn. What action or actions do you know in which the brain damage that they can cause you makes them not worth analyzing?
I await your comment!
- Ackman Won’t Invest in HP, Sees Too Much ‘Brain Damage’ (Bloomberg)
- Ackman: Short selling is ‘not worth the brain damage’ (Business Insider)