In his 2009 Berkshire Hathaway Annual Letter, Warren Buffett explains that he and Charlie Munger avoid investing in businesses with uncertain futures, even if their products seem exciting.
Historical examples like the auto industry in 1910, aircraft in 1930, and television sets in 1950, showed significant growth but intense competition led to the downfall of many companies, with survivors often suffering losses.
Predicting profit margins and returns in competitive industries is challenging. Therefore, Berkshire Hathaway focuses on businesses with predictable long-term profitability. Despite their cautious approach, Buffett acknowledges they will still make mistakes.
Here’s an excerpt from the letter:
Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950).
But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding.
Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy.
At Berkshire we will stick with businesses whose profit picture for decades to come seems reasonably predictable. Even then, we will make plenty of mistakes.
You can read the entire letter here:
2009 Berkshire Hathaway Annual Letter
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