Why you should invest in what you know

Emma-Lou explains why following your instinct can set you on the path to successful share investing.

How often have you read the financial news and spotted a profit warning from a retailer you used to shop with regularly?

Or watched a new business take off and kicked yourself because you had the chance to get on board before its profits and share price started to fly?

Investment opportunities are all around us. Taking note of what is and isn’t selling, where people are eating or buying property, what sort of cars they’re driving or even noticing a pattern at dinner party conversations can give you the information edge you need to invest successfully.

You will hear it time and again, but investing in what you know can pay dividends.

Both metaphorically and in reality, the “art” of successful investing does not always lie in solely keeping a close eye on share price patterns or poring over profit and loss statements. Well certainly not exclusively so, in any case. Sometimes having a gut instinct or a feel for a company is the best way to pick a winner. And it’s certainly a good starting point.

As consumers and customers ourselves we often – sometimes without realising it – occupy a prime viewpoint when it comes to spotting investment opportunities. Something as simple as watching what people around us are buying – or not buying – can put us on the path to investment success.

Legendary investor Warren Buffett is a fan of investing in what you know and has said time and again that his investment success has come from staying within his “circle of competence”.

Another famed proponent of the “invest in what you know” approach is Fidelity investment star Peter Lynch. Investing folklore has it that the former fund manager invested in undergarment manufacturer Hanes after his wife commented on the quality of its tights and stockings. When a competitor introduced a competing brand, Lynch is said to have taken samples of each and asked for his colleagues’ opinion on them. When they confirmed his wife’s opinion, he bought shares in the company.

Another story tells how Lynch profited from an early investment in Flying Tiger, an air freight company, because he had a hunch that air freight was the transportation mode of the future. His hunch paid off and he profited tremendously when the Vietnam War began and the company began transporting troops and supplies overseas.

Of course, there is no substitute for really getting to grips with the ins and outs of the companies you are thinking of investing in. As Lynch once said: “Never invest in any company before you’ve done the homework on the company’s earnings prospects, financial condition, competitive position, plans for expansion, and so forth.”

Sometimes a business can look more successful than it actually is. A great example of this is the airline industry. If you find yourself battling the crowds at a busy airport you might conclude that the airlines are making money hand over fist.

Over the 100 years or so of commercial flying, however, the losses have probably exceeded the profits in aggregate.
The reality of the airline business is that, despite more people taking more flights every year, it is a cut-throat industry with wafer-thin profit margins, vulnerable to the ups and downs of the oil price, regulation and powerful unions. Sometimes appearances can be deceptive.

At other times, however, you don’t even need to leave your house to see which way the wind is blowing. If you have teenage children, then you will have a front-row seat at the fast-changing world of social media.

You may well have seen your kids moving away from Facebook and spending more and more time on Instagram – no wonder then than Facebook now owns Instagram. As an investor, the key question is whether the faster-growing platform can make up for any slowdown in its maturing parent.

My colleague Tom Stevenson, spotted the opportunity at Caffe Nero in the early days of Britain’s coffee shop boom a few years back. He says: “when I started out working in the City 30 years ago, finding a decent cup of coffee was a hit and miss affair, and the arrival of the likes of Starbucks and Caffe Nero made the whole process more accessible and predictable. It was obvious that the new chains were pushing on an open door. But it required a further bit of lateral thinking to see that Caffe Nero’s more European style (and stronger coffee) would be a hit.”

He also makes an interesting point about his missed opportunity with Fever Tree. Again, it was not rocket science to spot that the upmarket mixer maker would be a success. But believing something and actually acting on that hunch are not the same thing. Investing is not just an intellectual exercise. It requires confidence and conviction too. Start with what you know, add some research into the mix and you’ll have a head-start on many other investors who are not prepared to roll up their sleeves or back their instincts.

Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Tax treatment depends on individual circumstances and all tax rules may change in the future.

Investors should note that the views expressed may no longer be current and may have already been acted upon. Past performance is not a reliable indicator of future returns. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets.

Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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