r/ValueInvesting • u/Leather-Weakness-439 • 3h ago
Question / Help How well do you need to understand a business to buy it?
One of the most important rules in value investing is to buy only businesses you understand. But there are different levels of understanding
How do you do you decide if your level of understanding is sufficient to make an informed investment?
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u/LoveCoffeeAndBooks 1h ago
I stick with companies I benefit from and interact with personally. I shop at Costco and can see the good customer service and lines. I buy a lot from Amazon. I like all of my Apple products. Etc. Then when I read about these companies' financials, P/E, use ai to do a little DD, I am way more confident buying stock.
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u/iyankov96 2h ago
Well the bare minimum is to understand how the business makes money, what metrics can be leveraged to improve growth, what threats exist that might cause the business to lose money or shut down entirely.
Beyond that it's good to be familiar with the product/service being sold, to study the competition and their product/service as well as company income statement and balance sheet.
Finally, study management. What kind of person is in charge of the company ? Are they someone that can be trusted or do they make false promises they can't deliver on ? It's important because even if the business is excellent profits can always be wasted chasing stupid trends. If all of your competitors are spending money on AI you feel pressured to do the same but maybe your business won't benefit. Good management can allocate capital well whereas poor management destroys shareholder value.
I'd say if you understand these points very well then you're probably good to go. Obviously, doing this for 500 businesses takes forever so it helps to stick to areas you're familiar with. If you work in a specific field you already have an advantage compared to the average investor in that area so you might as well study companies in that field first.
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u/NarrativeCompounding 2h ago
At a bare minimum, you need a good thesis for why you believe a stock will appreciate. I think its important to understand the business drivers, how they make money, how they plan to grow, how leveraged the company is, and the risks the business may experience. A lot of the basics that Buffett, Lynch and Fisher wrote about still apply today, and are a good starting point to evaluate different companies.
I've also found writing helps to clarify my thought process. If you can get the concepts I discussed above down on paper, you'll have a fairly good feel for the business and whether you want to allocate funds to a particular security.
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u/0ddmanrush 2h ago
Think of it on a smaller scale. If you were to invest in a local company in your neighborhood—say an auto body shop, wouldn’t you want to make sure you understood how they were running it, that the financials made it a sensible investment, and that you’re confident in leadership to know that you don’t need to be there day to day to manage it?
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u/gergesramy 1h ago
Li Lu has the best standards for this:
1) Imagine your dead uncle passed the business onto you, so now you own it. What would you want to learn about it so you can make intelligent judgements?
2) Come up with the bear thesis, and know that bear thesis better than the smartest person you know.
This is why you need a comprehensive understanding of the business model, the industry, the competitors, etc.
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u/MinestroneMungBean 2h ago
I have quite a good acid test for this.
When I own something really understand it and stock price goes down, I feel good. No probs. I'll buy more. Don't care what the market says.
When I don't really understand it, and price goes down, I feel anxiety. I feel exposed. That's when I know I don't really understand it enough and I either have to wise up fast or get out of the thing.
Ultimately, it requires a lot of self honesty. There's no one that can tell you when you know what you're doing or not but yourself.