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Summary The idea of “invest in what you know” is misunderstood. Using the products of a company doesn’t preclude you from doing more work. The financial implications must be understood before you can say that you “understand” the company. If you are an expert in an industry, use this knowledge as an edge to help you spot opportunities earlier than anyone else. Invest in what you know, but only if you truly “know”. I recently came across an article on Peter Lynch on WSJ where he clarified what he really meant by his trade mark saying of “invest in what you know.” If you are not familiar with Peter Lynch, here’s a brief introduction. He was the iconic manager of Fidelity’s Magellan Fund between 1977 and 1990. Turing his tenure, he averaged an annual return of 29.2% . Keep in mind that the Magellan Fund was not a special hedge fund of some sorts, it was a plain vanilla mutual fund. So despite a lack of more sophisticated financial instruments at his disposal, Peter Lynch was still able to churn out extremely impressive returns. What was his secret? His investing philosophy is commonly (mis)quoted as “invest in what you know.” Don’t Just Invest In What You Know Peter Lynch’s investment philosophy was lauded by the investment industry and his influence even extended to small-time investors. Speaking from personal experience (some of which I’m sure you can relate to as well), amateur investors often believe in their stock picks because they “know what they are buying.” But do they really understand the company? For example, how many of your friends own Facebook (NASDAQ: FB ) but have no idea how to read a balance sheet or an income statement? How many people buy Exxon (NYSE: XOM ) just because they use its gasoline? During the interview, Peter Lynch stated: “I’ve never said, ‘If you go to a mall, see a Starbucks (NASDAQ: SBUX ) and say it’s good coffee, you should call Fidelity brokerage and buy the stock.'” Similarly, just because you enjoy using Twitter (NYSE: TWTR ) or Facebook, it doesn’t mean that those are good stocks to buy. During the post-recession bull market, those who bought into the popular stocks made a lot of money, further perpetuating this false idea that “invest in what you know” is all that is needed to be a great stock picker. Unfortunately, just because you “know” the company, it doesn’t mean that you don’t have to do the hard work. For every stock that I own in the V20 Portfolio (which you can learn more about here ), I do thorough research before investing even a penny. With the market awash in “easy money” these days, particularly with the surge of FANG [Facebook, Amazon (NASDAQ: AMZN ), Netflix (NASDAQ: NFLX ), Google (NASDAQ: GOOG ) (NASDAQ: GOOGL )] investing, getting rich quickly has never been more simple. While those who rode the gravy train have made a lot of money (at least on paper), the end result does not necessarily indicate that they made the right decision initially. Stocks can only go up or down, much like how a ball can only land on red or black in a fair game of roulette. I think we can all agree that gamblers who claim that they “beat the system” by winning at the game of roulette are certainly delusional. Yet the success of FANG investing is celebrated. In Peter Lynch’s words, “People buy a stock and they know nothing about it. That’s gambling and it’s not good.” What he means by “know nothing” is that investors use the products and services, but know nothing about their financial impact. Next time ask your friend what Facebook’s ARPU is, or what Starbucks is earning on a cup of coffee, and more likely than not, their look of bewilderment will betray their “knowledge” about the company. And this is a dangerous thing. What Peter Lynch Really Meant To Say Was… … That you should use your specialized knowledge of a certain industry to augment your analysis. If you operate oil rigs, you understand the core operations of the industry better than anyone outside of the industry , and this gives you a unique edge. But this doesn’t preclude you from doing actual work. Can the company pay off its debt in time? How profitable is the backlog? Is the management selling off assets just before the industry swings back to a boom phase? These are all questions that you likely cannot gain from your typical work without you putting in extra effort. With metal prices reaching multi-year lows, Peter Lynch gave a specific example. He said, “If you’re in the steel industry and it ever turns around, you’ll see it before I do.” That person can then use this knowledge to predict the company’s revenue, earnings, cash flows, etc., and spot an opportunity before anyone else. How I Apply Peter Lynch’s Philosophy Funnily enough, Peter Lynch doesn’t specialize in any specific industry. Where he lacks in real industry experience, he makes up for it with intense research. Similarly, I am not what you call an aviation expert (or even a fan), and I am invested in Spirit Airlines (NASDAQ: SAVE ). I’m not a subprime borrower and I’m invested in Conn’s (NASDAQ: CONN ). I don’t use VoIP phones (in fact I use Skype) and I’m invested in MagicJack (NASDAQ: CALL ). I have confidence in these stocks not because I particularly enjoy their products (for the above cases I’m not even a user), but because after thorough research, I concluded that these stocks were attractive enough at the prices that I bought them at. Ironically, I don’t invest in a lot of things that I do use every day. I’m the owner of multiple HP products yet I don’t own any HP shares. I use Google all the time and I never bought a single share. I don’t own these stocks because I know that just because I’m a user, it doesn’t make me anymore “in the know” than Joe across the street. In addition, the prices that these stocks were trading at were simply not very attractive to me. Notice how this is the polar opposite of “invest in what you know at any price” kind of mentality that is so prevalent in today’s markets. Takeaway It may be quite shocking to hear that “invest in what you know” isn’t all that you need to be a good investor, but I hope that this article clarifies what Peter Lynch really meant to say. Now one thing I want to make clear is that I don’t mean to discourage you from investing in what you know, it’s just that the threshold of “knowing” is a lot higher than what everyone thinks it is. Thankfully, Seeking Alpha has a wealth of information available for you to discover. From small caps all the way to mega caps, there is an expert covering virtually any stock that you can think off. I encourage everyone to read some of the analysis on their favorite stocks, and I’m sure that you will discover something new. From “not knowing,” you can slowly build up your knowledge, and be confident enough to say that you truly “invest in what you know”. Why Follow Me I personally invest a ton of time researching every single company that is in the V20 Portfolio (+43% YTD). It’s not a model portfolio, it’s a real money portfolio where you can see the real impact of portfolio decisions and their long-term consequences . Investing is straight forward (though not easy) if you know where to look. If you are looking for a place to find some ideas that could complement your own portfolio, you can click the ” follow ” button and be updated with my latest insights. Scalper1 News
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