I recently read a book titled ‘The Richest Man in Babylon‘. More about general investing than stock selection, it’s set in ancient Babylon and is an easy read and full of useful parables for modern savers and investors.  One story stuck with me.

I paraphrase, but a rich man in Babylon teaches a poor man first how to save money, and then to invest it and make it grow. The poor man tells his teacher proudly that he gave his savings to Azmur the brick-maker who was travelling to Phoenicia. The brick-maker would buy rare jewels while he was there and they would sell them and split the proceeds on his return.

Can you guess where this story is going?

The teacher replies ‘you’re an idiot. What does a brick-maker know of rare jewels? Would you ask a baker to explain the movements of the heavens?‘ Sure enough, the wily Phoenicians tricked Azmur and sold him bits of worthless coloured glass instead of jewels.

A lesson for ASX investors

It’s often said that there’s nothing new under the sun in investing, and you might be surprised to know how often modern managers of multi-million dollar companies step outside their area of expertise.

Capitol Health Ltd (ASX: CAJ) may have done it when it partnered with Enlitic to deliver machine-learning diagnostics for its scans. As diagnosticians, Capitol Health is likely in a better place to identify coming trends/needs in the sector, and Enlitic’s technology certainly appears useful.

However – and I’m not beating up on management here – it’s a different question as to whether management has the skills to determine that a US$10 million investment in an unprofitable start-up is likely to reap benefits for shareholders in time. The entirety of Capitol Health is only valued at A$83 million today and the company is under some financial stress, so the investment was significant.

Other more egregious examples include Harvey Norman Holdings Limited’s (ASX: HVN) acquisition of a dairy farm, which appeared to be a bid to profit from Australia’s booming dairy industry, but understandably sent shares down more than 10% at the time. Investors were no doubt wondering, ‘what does this electronics retailer know about dairy farming or agricultural property?

Another time, TFS Corporation Limited (ASX: TFC) decided to diversify from running sandalwood plantations into developing pharmaceutical therapies from said sandalwood. Whatever the eventual outcome, the venture is extremely expensive and outcomes from any kind of clinical trial are uncertain.

One of the best known examples will be Woolworths Limited (ASX: WOW) and its Masters Hardware venture. Despite the apparent similarities between a hardware warehouse and a grocery shop, and competitor Wesfarmers Ltd‘s (ASX: WES) (who also owns Coles) success with Bunnings, Woolies’ management just couldn’t make it work. It cost shareholders a stack of money that they won’t get back.

What does this brick-maker know of rare jewels? 

The risks increase when the money diverted to the grand new idea increases. If Masters or pharmaceutical sandalwood research only cost $5 million bucks, it wouldn’t be a huge issue. When management is talking about expensive diversification into unrelated businesses, it’s important for all investors to ask ‘what does the brick maker know of rare jewels?

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.