The Business of Value Investing: Six Essential Elements to Buying Companies Like Warren Buffett

Chapter 11. Avoiding Common Stumbling Blocks

I'd rather be approximately right than precisely wrong.

—Warren Buffett

Investing is by no means an exact science. In fact, a great deal of investment analysis hinges on future assumptions about a company's cash flow generation. It's not uncommon to see different investors use different methods to derive the intrinsic value of a particular business. But at the end of the day, most valuations hinge on the cash flow generation of a business. The exceptions are special situation investments, such as liquidations, spin-offs, or arbitrage.

All realistic investors realize that they will make many mistakes throughout their careers. Even though value investors are risk averse and strive to eliminate most risk by strictly adhering to the concept of a margin of safety, all investing entails risk. There is always the incalculable risk that the business environment will weaken, or as we've seen in 2008 and spilling over into 2009, the economy can come to a near standstill and affect all businesses. Business risk and economic risk are risks that all investors in all asset classes assume when participating in the capital markets. But these business risks are exactly the reason the philosophies of value investing have become such a relied-on foundation for long-term investment success.

The best value investors concentrate their efforts on avoiding avoidable mistakes, such as investing in a business they don't understand because it looks cheap on the balance ...