Blog

Investing In What You Know

February 15, 2016

Investing in companies that you know has been an investment philosophy preached by many famous and rich investors.

Specifically, this philosophy comes from a famous mutual fund investor Peter Lynch.  His philosophy states that people should invest in what they know, for example companies that they interact with every week or every day.  If you do not understand how a company makes money and if they will continue making money, how can you expect to make money by investing in them?

IDEAS ARE EVERYWHERE

Look into brands you use for entertainment such as Netflix or companies for buying your low-cost items such as Walmart.  Reading about companies that you interact with on a daily basis will not only make understanding the company easier, but it will also be easier for you to be interested in the information you are reading about the company.  It is also easier to understand why the company would succeed or fail if you interact with the company.  Since I go to a certain grocery store every week, and I notice that there is always better selection, service and more visitors than other stores, this is an observation that can help you identify what grocery store to invest in.  Additionally, thinking of trends within the company can also be important for timing your investment.  If you notice that your favourite store has been getting less busy in the summer year over year, you may want to avoid the stock in the summer since they do not perform very well.

FOLLOWING TRENDS

Continuing with investing in what you know and trends, one can find investment ideas in their day-to-day observations.  If you notice your friends increasingly go out to buy the new Apple iPhone, investing in Apple stock may be smart because you can directly see that a company’s product is growing in popularity which directly translates to more revenue for the company.

Of course, only using these observations can be dangerous and one should look into the company’s financial performance for better insight, as well as read other analyst reports on the company.  Investing in what you know should be a starting point for finding investment ideas.  This philosophy should not dictate all the stocks you buy, because although a cafe you visit every day serves great coffee, doesn’t mean their stock will rise over time.

EXAMPLES

To illustrate, I will give a few examples of companies I know and like from their service or product use.  The first example is Visa (V).  I have been following the company since I first got my Visa when I was 19 years old.  I noticed as my other friends turned 19, more of them had gotten Visa credit cards instead of Mastercard credit cards.  From this observation I thought Visa was in a good position to grow.  After reviewing an experienced analyst report I found on google, my observations were confirmed.  If I had invested in Visa at that time in the start of 2014, the stock price was $54.46, and today the stock price is $70.42.  That is a $15.94 per share profit.  In the end, if I invested a $1000 at that time I would now have $1,267.56.  However, I will use one of my favourite companies GoPro (GPRO) to illustrate the dangers in investing in what you know without due diligence.  GoPro is a company I follow closely because I love their products and have many friends that are happy customers.  If I bought their stock in the summer of 2014 for $30 a share, I would have lost almost $20 a share as their stock price is now at $10 a share.  A $1000 investment would now be worth $330 today.  How could I have avoided this? Well, if I followed the company’s financial statements I would have seen that through the past year and a half, they have been struggling to meet analyst expectations with sales each quarter.  Not meeting analyst expectations can cause the stock to drop because the company’s value is now lower since they have lower than expected revenue.

FRIENDS HAVE GREAT INSIGHTS

Want to invest in what you know but also want a diversified portfolio?  Create an investment club with your trusted friends or family to use their knowledge of what they know for diversification in sectors you are not familiar with.  Sign up for the beta application of Voleo today.

Written by Voleo Analyst, Mike Nesselbeck