Buying What You Know

In my recent review of “Rule #1” I talked a bit about people taking Buffett quotes and twisting them. A while ago during a conversation about “Rich Dad, Poor Dad” a similar idea came up that people can use aphorisms to mean whatever they want. One Peter Lynch quote that I think gets bent beyond recognition is “invest in what you know“.

Years ago I was working in San Francisco at the tail end of the dot-com boom (I think I may have caused the bust after I arrived). RIGHT at the height I got into buying tech stocks with a NY stock broker (JDS Uniphase and all the usual suspects). I liked to talk to people and say it was ok for me to be buying tech stocks since I worked in the field and had a deeper understanding of the technology than the man on the street (I was investing in what I knew, dontcha know!). This didn’t stop me from losing 75% when the bubble burst (and forced me to realize that I was just being greedy chasing the trend like everyone else).

During the boom, I was talking to one man who called me on my foolishness. He looked me in the eye and said “You may have a computer science degree and be working at a startup, but that has nothing to do with tech stocks. You don’t understand global demand for the various technologies being developed, you don’t understand the financing behind the companies, you don’t understand the coming economic cycles, etc, etc”. I was a bit annoyed at the time (who likes being called on their foolishness?), but if I’d listened to him and got out I could have avoided a pretty good shearing.

A psychologist I know gets a newsletter about pharmaceutical and biotech stocks and buys based on information from it because “it was his field, so he had a deeper understanding of it.” He isn’t someone who’d be particularly responsive to warnings so I just nodded and smiled.

My brother wanted to buy Lululemon’s IPO because his girlfriend shopped there and he saw so many new stores opening up. He quoted Lynch’s idea that he was seeing a trend before it hit Wall Street. I cautioned him that he wasn’t the only one who saw all the expensive yoga-wear being sold and that IPOs were notoriously volatile. Tim Horton‘s IPO got quite a bit of attention, mostly because people like their coffee I think.

In “Your Money and Your Brain” Jason Zweig talks about how investors, including professionals, tend to over-buy geographically nearby companies. I think its possible if you’re a domain expert or if you have extensive experience with a local company that you might be able to shave a small amount of time off of you company research (if that’s your investing strategy). However, I suspect just buying things just because they’re familiar is a very dangerous practice.

15 replies on “Buying What You Know”

This should have been two posts “Buffetisms – are they all bullsh**?” and “Buy what you know – (but only if you know something economically useful)”. 🙂

On the topic of Buffet – yes, I’m starting to think his “cute phrases” are just fluff – as you pointed out last week his “don’t lose money” saying just doesn’t make any sense at all if you are investing in equities. Senility anyone? 🙂

As for the “buy what you know” – this really doesn’t work for most people. As your buddy pointed out, the fact that you might have been an expert in a certain field doesn’t mean you know anything about that field from an investment point of view. For the common man (ie your bro), any trends he notices will be noticed by many other common men and women – being one of the early “noticers” is extremely unlikely. I don’t know how Lynch did it, but even he quit early while he was ahead of the game.

On the same topic, employees often overweight themselves in company stock, because their familiarity with the business makes them bullish about it. If only it were that easy!

I’m guessing in this context “know” is supposed to mean “understand the market for”.

I understand the market that operates in my industry and think it’s a reasonable bet over the next 5-10 years. This is not as long as the timeframe of my investments though, and if I’m wrong, I don’t want to be out a career and a retirement. I understand well enough to know that it’s not right for me to invest in it.

?Buy what you know – (but only if you know something economically useful)? sums it up much better, Mike. When are you releasing your book of wisdom?

I’m guilty of this too. Part of my job description is predicting what will happen to the construction industry and sifting through commodities info etc so I do mess around with investments in those arenas (that looks wrong; arenae?). “Luckily” I was smacked upside the head for my hubris early, like Mr Cheap, so I keep it to a very very tiny part of my gargantuan wealth.

Lynch himself has come out several times saying he thinks people have taken his message out of context. Yes you should only buy what you are knowledgable about, but that doesn’t mean you should buy something just because you are knowledgable about it. Valuation still matters even if you think the business will be successful in the future.

I am not a big believer in buying what I “know” now, nothing I knew had come out ahead

or you could just buy BRK stocks, then you know you’re buying into what Buffet knows, and not yourself ;P

I recently did, and liked the fact that I don’t have to worry about the stock, or think about it

I think this is a classic case of people not “knowing” very much or simply not “knowing” the right things. (i.e.: something economically useful).

“Investing what you know”, is really just a re-word of the entire premise of fundamental analysis. So I don’t know that the snippet can really be taken in a void. At best it’s useful advice when combined with another 20 or so “snippets”.

You’re right about this maxim being misinterpreted because I’m the same way, I have a CS background but I don’t understand tech stocks. I don’t understand how they are valued when there is no income stream, there is no concept for PE ratios and all that other good stuff, etc. The reality is that knowing the underlying tehcnology doesn’t make me qualified to know the business … which is dangerous when you’re investing in stocks. 🙂

I know nothing as well but I believe that by poring over data I could come up with a model that helps investors achieve a rising annual dividend income.
I think that Buffett knows what he is doing because:
1) He bought smaller stocks that had a liquidation values that were several times his acquisition price. He basically acted like private equity. As his partnership/berkshire grew larger he bought larger companies.
2) He did arbitrade opportunities by purchasing stock in companies that will be acquired by a specific date.

I know of a colleague of mine who bought a stock in GRMN last year because she thought she knew it all – she had seen how the company hires a lot of people and its business is booming. For a while my friend was lucky as GRMN leapt from $50 in May 07 to $120 in Sep 07, before ending up in the upper 30’s most recently..

Buying what you know is fine, but we don’t usually know as much as we like to think that we do! That (betimes considerable) gap between actual knowledge and perceived knowledge leads a lot of people to make foolish choices with money, whether in investments, insurance, or any other related area.

Leave a Reply

Your email address will not be published. Required fields are marked *