Lesson 5. _____________________________________________________________

Date: 2015-10-07; view: 466.

One of Warren Buffett's maxims is, "Never invest in a business you cannot understand." This is the key lesson that the Enron bankruptcy holds for the investor. (To learn more about how investors were led astray in the Enron scandal, check out Enron's Collapse: The Fall Of A Wall Street Darling.)

Enron succeeded in deceiving the "smart money," such as pension funds and other institutional investors for years, before the company's lack of transparency and policy of obfuscation, which was in turn prompted by its accounting gimmickry, caught up with it.

Enron was founded in 1985 through the merger of two natural gas pipeline companies. But by 2001, it had become a conglomerate that owned and operated gas pipelines, electricity plants, water plants and broadband assets, and also traded in financial markets for similar products. As a result, Enron's business model was very complex, and its financial statements were difficult to understand because of the complexity of its financing structures involving hundreds of special purpose entities and off-balance-sheet vehicles. (Read about some typical off balance sheet items in Off-Balance-Sheet Entities: The Good, The Bad And The Ugly.)

The lesson here is that a company that is not being fully transparent or that is using creative accounting might be masking its true performance and financial position. So why bother investing in a business that is hard to understand, when there are numerous investment alternatives in the marketplace?