The technology rally that began in the mid-1990s was characterized by a large number of internet-based startups and other technology companies trading at obnoxiously high earnings multiples. In most cases, these newly listed technology companies commanded crazy valuations in spite of never making a profit.
Legendary value investor Warren Buffett kept away from the tech rally and his company Berkshire Hathaway was the only major financial institution which did not invest in a single tech stock. On being asked about his aversion to tech companies, Buffett clearly replied that while he had nothing against tech companies, he was unable to understand their business models and predict their future earnings and this made him stay away from the technology sector as a whole.
A number of financial “analysts” and “experts” criticized Buffett and many even called him a “dinosaur” for not investing in tech stocks. Surprisingly, when the tech bubble burst a few years later in 2000, the above-mentioned analysts had lost their clients billions of dollars while Buffett emerged unscathed and relatively richer.
So what “secret weapon” does Buffett use to spot speculative bubbles and stay away from them? Let’s find out.
1. Invest in businesses you can understand
“There are all kinds of businesses that Charlie and I don’t understand, but that doesn’t cause us to stay up at night. It just means we go on to the next one, and that’s what the individual investor should do.”
The above Buffett quote illustrates the fact that Buffett and others at Berkshire Hathaway have always followed this rule thoroughly. This rule kept him away from the tech bubble in the 1990s and the real estate bubble in the 2000s. Buffett prefers stocks with a solid track record and businesses that are easy to understand and assess. As retail investors, we too can use this rule to stay away from risky investments that can lead to massive losses later on.
2. Buy value
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
This popular Buffett quote indicates that investors are better off buying low priced value stocks instead of getting into hot growth stocks which tend to be very expensive and richly valued. This protects your investment even if the market crashes and is a sure-shot way to survive any equity bubble.
3. Stay away from the latest fad
“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
This Buffett quote advises people to stay away from popular stocks and the latest investment fads. Most popular investment ideas generally attract a lot of public participation and when the whole mob gets in, the stock in question tends to top out sooner than later. The same thing is true for entire business sectors; the tech sector bust in the 1990s and the real estate sector crash in the late 2000s are glaring examples of what happens after most buying frenzies.
Use the above-mentioned advice to stay away from the next equity bubble. Instead, use your time and money to create a long-term portfolio of value stocks. Value investing is the only time-tested and proven method that allows you to consistently make money in the equity markets. Learn the basics of value investing by signing up for the Millionaire Investor Program 2-Hour Seminar. It’s totally free of charge!