I've written about the importance of knowing your investments before you buy them. You might remember the story about Fidelity Magellan mutual fund legend Peter Lynch, who would spend his Saturdays walking around Boston looking to see where shoppers were spending their money. Then he'd invest Magellan's money in the same company's stock.
That's why retailers like The Gap, Target and Boston Chicken found their way into Lynch's high-flying fund.
An article in today's Motley Fool has a similar theme. Writer Selena Maranjian tells the story of buying America Online back in 1995 after being impressed on how easy the site was to use and how many of her friends and family were using AOL, too. Her $3,000 investment in AOL has turned into a $215,000 windfall in 2008.
Following the "buy what you know" theme, Selena says it's important to actually use the product or service - or talk to people you trust who use them. A lot of it just common sense, she writes. "Do you have some SanDisk (Nasdaq: SNDK) memory cards in your digital camera? Do you use a Cisco Systems (Nasdaq: CSCO) router in your home computer network? SanDisk stock has been volatile over the past decade, but those who've hung on have enjoyed a compound annual growth rate of 21%, and a total gain of over 575%. Cisco shares have increased in value more than 15-fold in the past 15 years, despite that big stock-market hiccup a few years ago. These companies have performed rather well, right under our noses."
Conversely, stay away from companies you don't understand. In other words, if you're not sure what a company does, or "gets" the product it makes, avoid buying the stock. The big reason is you won't know when the company goes off the rails. "Biotechnology companies present a good example, as do new-technology firms," Selena writes. "Think of Energy Conversion Devices (Nasdaq: ENER) -- if you're invested in it, do you have a good grasp of its solar energy technologies, and those of its competitors? Can you discuss the benefits of amorphous silicon technology versus polysilicon? Unless you're rather comfortable with your understanding of its exposure to credit and other risks and you're aware of and approve of its plans to turn itself around, steer clear."
It's a pretty simple concept, but one overlooked by a lot of investors. If you understand a company, you're able to ride out the inevitable bumps and bruises that every company earns over the long haul. Selena points to Dell, which certainly has had its issues, but which also has risen above those problems to be a good long-term play.
Good advice. Better yet, simple, good advice. Take it and prosper.