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Legendary investor Warren Buffet, among others, is notorious for telling investors to buy what they know. Basically, Buffett and his enthusiastic followers suggest investing in companies that you really understand or at least know enough about them to be able to explain how they make money – i.e. the company’s business model. Though it’s certainly not without merit, buying what you know is not necessarily an investment strategy that will yield the most investing success. Here we explore some of these limitations and suggest that investors might really be better served by buying what they can learn.
Many new investors will find it difficult to delve into the business models or 10-k statements of publicly traded companies for some obvious reasons, the most important being time and/or lack of knowledge. Not many of us can listen consistently to companies’ earnings calls and even if we could, we might not really appreciate what is being discussed. Truly understanding a company’s balance sheet and overall financial direction requires specialized knowledge that most investors do not immediately possess. There are, however, many online resources that can help shorten the learning curve on gaining knowledge about a company you own or have intentions of buying.
A pitfall in just investing in companies that you are comfortable with is the opportunity cost of not owning companies not as prominent. Most investors know that Exxon Mobil sells gasoline and that Johnson and Johnson make a variety of pharmaceutical and health and beauty products. A valid argument can be made that this companies bring predictability and help mitigate risk in one’s portfolio; however, the fact remains that the biggest gains from stocks typically come from companies in the earlier phases of growth instead of the latter phases.
Typically, big well known companies cannot grow at the pace they did when they first became publicly traded. So then the idea is to learn about these companies before they experience their biggest growth and consequently their most explosive stock price appreciation. Cisco Systems and Microsoft are two of the most recognized technology companies on the planet. Microsoft went public in the ’80s. Back then, not many people really understood “Windows” or “email,” which have become essential and necessary in everyone’s lives. In the early ’90s, who knew what the internet was, much less that it would eventually be used without wires and in conjunction with routers? Cisco systems certainly did, and learning conceptually about this company and pulling the trigger would have earned huge returns on an investment. There are also online sites that help navigate thru some of the most recent companies and potential high growth stocks. No one should go out and invest solely into small, growing companies or recent IPOs, but learning about these companies could make you a more balanced investor.