Invest in What You Know

Buying shares in companies you are familiar with can be a road to riches

Understanding the Business Leads to Better Investing Decisions
As investors, we believe that you can take the financial statements and filings of a business and calculate it's intrinsic [true] value.  You cannot accurately come up with an estimate for intrinsic value if you don't understand how a company makes money.  For example, if you don't know anything about telecommunications equipment, you probably shouldn't invest in Lucent Technologies.  Why?  How are you going to forecast future profits and losses if you don't understand the products the company sells.  Coca-Cola, on the other hand, is simple, straight-forward, and can be understood by a child.

When giving speeches at business schools, famed investor Warren Buffett talks about each investor having a "circle of competence".  This circle of competence consists of all the businesses you are familiar with and understand.  If you worked as a checker at a supermarket for ten years, you should be able to scrutinize the financial statements of a grocery store and pinpoint strengths and weaknesses of the business.  The size of your circle of competence isn't as important as having the borders clearly defined.  If you are unfamiliar with insurance, don't even try to invest in insurance stocks.  Likewise, if you don't understand the internet, don't touch an internet stock despite what your broker or family says. 

Finding Investment Ideas
How do you find companies you can understand?  Take a trip to your local mall to scout out the stores to see what's popular.  Pay attention to where your kids want you to take them for back to school shopping.  Peter Lynch, one of the most successful money managers in history, got some of his best investing ideas from listening to his wife and kids after they came back from shopping?  In fact, Lynch bought stock in Hanes after his wife brought home the newly-introduced L'eggs while at the grocery store.

Another way to get investment ideas is to go through your pantry, cupboards, laundry room, and garage to find products you use regularly.  You can generally find out who manufacture is by looking on the back of the packaging.  You may be surprised to find out who is selling you some of the things in your home; what do Tide, Pampers, Always maxi pads, Pantene Pro V, Charmin Toilette Paper, Bounty Paper Towels, Folders Coffee, Crest Toothpaste, Pringles potato chips, Downy fabric softener, Oil of Olay, Bounce, Cascade, Cover Girl, Fixodent, Mr. Clean, Pert Plus, Pepto Bismol, Old Spice, Noxema, Millstone Coffee, Max Factor, Febreze, Giorgio Beverly Hills, Head and Shoulders, Herbal Essences, Gain, Ivory, Luvs, Joy, Scope, Sunny Delight, Tampax, Zest, and Vidal Sassoon have in common?  They are all made by Proctor and Gamble.  Sara Lee is another widely known company with brand names that include Hanes underwear, Hillshire Farm, Playtex, Sara Lee foods, Champion athletic apparel, L'eggs, Jimmy Dean, Ballpark Hotdogs, Kiwi Shoe Care, and Wonderbra.

Price Still Matters
Just because you find several companies you feel comfortable with doesn't mean you should automatically invest.  The "circle of competence" test should merely be a starting point to give you investment possibilities.  It is your responsibility to find the best companies that are trading for the lowest prices - a combination which will produce stellar returns for your pocketbook.

Copyright © 2002 Joshua Kennon