Thursday, January 31, 2008

Rule #1: Invest in companies you know and use.

This is my first rule of investing because its a easy way to find good investments. This philosophy is something that was made popular by one of the great investors Peter Lynch. This does not mean to immediately buy every company whose product you use, but use that as a starting point to do your research.

Now when starting out to invest money, it can be difficult to trust your own instincts, especially if they are contrary to the so called market experts. I myself have fallen prey to this and lost many a good investment opportunities.

For example, when I started investing in early 2005, I was a subscriber of Netflix Inc. I loved their service, and I was so impressed that I even tried to get my friends on it instead of blockbuster. So naturally, this was one company I wanted to buy. The stock at that time was trading below $10. But this was also a stock that had dropped in value form $35 just an year ago. The reason was that Amazon was going to enter the online movie rental business, and video on demand would kill Netflix. I did do my homework and still believed in the Netflix story as they had a strong brand and good financials. But I was afraid of being a novice and not knowing what I was doing. So I just decided to follow the market experts and not buy the company. As you guessed it, within 6 months, the stock had $30. A 3-bagger in just 6 months that I missed.

I was also using XM satellite radio at that time, and did like their service. But this was a business that had never made a profit, and was eating through their cash reserves at an alarming rate. But this was a stock that was very popular with the experts, and so I decided to buy it. And the stock promptly started its decline form the high 20's to the low teens.

There are many other examples of missed opportunities with companies I loved. Chipotle Mexican Grill and Google are two of them that immediately comes to my mind. At one point in time, I used to eat from Chipotle every day as I loved their grilled chicken burrito. But when the stock became public in the mid 40's, I thought it was very pricey. I wanted it to come to the 30's before buying it. But that never happened. The stock currently is trading way over the 100 mark these days, and I missed another 3-4 bagger.

And finally Google Inc. Now this is a search engine I had used since the late 90's back in India when no one else knew what Google was. Once I found out about Google, there was no other search engine I used. But when the company when public in 2004 around $85, I didnt buy i t. My reason was that I could not understand the business. In all the years I had used Google search, I had used the sponsored links just a handful of times. And I could not understand how they could make so much money from advertising. In 2005 when I started investing, few of my colleagues had bought the stock in the $130 range. I still didnt pull the trigger. We all now know the Google story. Within a matter of 3 years, the stock touched almost $750, an easy 6-bagger that I missed.

So moral of the story is, if you like a company, and have done enough research on it, then go ahead and buy it if you like it, no matter what the expert opinion o it is. More often than not, you will come o ut ahead of the market.

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