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Warren Buffett: Do Not Part With Your Crown Jewels

In a previous piece, I discussed a mental gap that investors suffer from - the inability to conceive of stock investments as more than just numbers on a screen - and how they should use Warren Buffett (Trades, Portfolio)'s real estate analogy to bridge this gap. While reading Buffett's 1993 letter to shareholders of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B), I came across a different instance of such thinking; this time concerning corporate management.

Domain-specific understanding

Before we turn to that, I want to briefly explore the concept of domain specificity as it relates to knowledge and understanding. Simply put, it is the phenomenon wherein individuals with extreme competence in one particular area are not able to translate that competence into other, seemingly similar areas. For instance, a person may be a very talented and capable medical doctor, with an excellent bedside manner, whilst also being completely inept when dealing with people who are not their patients.

In other words, people who really should know better tend to forget their training and lose their instincts when taken out of the narrow field (domain) in which they practice. With that in mind, let us turn to this passage from Buffett's letter.

Do not part with the crown jewels

Buffett wrote:

"We continue to think that it is usually foolish to part with an interest in a business that is both understandable and durably wonderful. Business interests of that kind are simply too hard to replace. Interestingly, corporate managers have no trouble understanding that point when they are focusing on a business they operate: A parent company that owns a subsidiary with superb long-term economics is not likely to sell that entity regardless of price. 'Why,' the CEO would ask, 'should I part with my crown jewel?'

Yet that same CEO, when it comes to running his personal investment portfolio, will offhandedly - and even impetuously - move from business to business when presented with no more than superficial arguments by his broker for doing so. The worst of these is perhaps, 'You can't go broke taking a profit.' Can you imagine a CEO using this line to urge his board to sell a star subsidiary? In our view, what makes sense in business also makes sense in stocks: An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business."

Corporate managers understand the value of owning a stable, cash-generative subsidiary. The capital value of the subsidiary will probably grow over time, but most managers would not think about selling it to realize that gain. They value the high probability of that cash stream continuing in the future more than they value the once-off payout today.

When it comes to stocks, however, Buffett believes those same prudent stewards of investor capital will tend to forget their training and lose their instincts. Why is this? My personal theory is one that I touched on in a previous piece - it has become so easy to buy and sell the stock of publicly traded companies that investors have trouble assigning weight to their holdings. Would investors take as short term a view if it were harder to buy and sell stock? I think so.

This is not to say that the existence of public markets isn't a net benefit to the financial system - they almost certainly are - but I do think we need to understand how the ease of conducting transactions affects our perception of investments. And investors would do well to think of themselves as owners and stewards, rather than temporary holders of companies.

Disclosure: The author owns no stocks mentioned.

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This article first appeared on GuruFocus.