Know whom you’re getting into bed with


A man had travelled to another country when he received a call from his sister telling him their father had died. It was physically impossible for him to travel back home in time for the funeral, but he told his sister to take care of the arrangements and send him the bill.

When he got back home, he got a bill for several thousands of shillings, and paid. The following month, he got another bill for Sh5,000, which he paid. The next month, he got a similar bill. When he got another Sh5,000 bill the third month, he called his sister to ask what was going on.
“Oh,” she said, “I forgot to tell you. We buried Dad in a rented suit.”

This story, abridged from investor Warren Buffet’s 1984 annual letter, brings home an important lesson on why it is important that you have a clear picture of what you’re paying for before you commit to making an investment, and how managers/executives can manipulate earnings.

The preparation of financial statements requires a large number of estimates. Thus, when analysing a company, you should examine several years’ worth of financial statements; not just the recent ones.

Questionable dealings

Management plays a critical role for me when I’m making an investment. You have to remember that many Kenyan companies have had their fair share of questionable dealings in the past, with the management pillaging the firm, overpaying themselves, deploying capital poorly, taking advantage of shareholders with free stock options or hiring from within their clan.

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Investing, as you might know yourself, is first and foremost a mental exercise that should help you avoid getting into bed with bad management. Therefore, perhaps one of the most important pillars of investment success is continuous learning.

It’s no fluke that some of the best investors in the world spend a significant chunk of their day reading, keeping up with what’s happening in the industry they’re interested in, talking to smart investors and reflecting on what they’ve learnt.

We all walk around with views of the world that we believe are correct. You are compelled to change your mind only when you confront a reality that disagrees with your beliefs.

But outstanding investors do two things that most of us never do: they seek information or views that are different from their own; and they update their beliefs when the evidence suggests that they should. Neither task is easy.

 

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