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Invest in What You Know? (Part 1)

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Recently a company emailed me to tell me about their product. The product re-introduced me to the idea of investing in what you know. Peter Lynch, of Fidelity fame, may be the biggest proponent, and Warren Buffett, may be the best known. When those two minds agree on any piece of investing advice, it is wise to listen...

... or is it?

I was a software engineer working on websites in 1999. (I'm sure you can see where this is going.) What I knew then was building websites. Should I have invested in them? In hindsight, the answer to that question is easy... No. It was extremely hard to know where to invest back then. I remember thinking that software was going to be distributed online and Egghead Software (Symbol: EGGS) was looking like it would be the Amazon.com (when Amazon was mostly books). It was trading at around $18 a share when I bought 100 shares. Later on that day it went up to $32 a share, but by the time my meeting was over it was down to $13. I suppose you could say that wasn't investing... it was speculating.

I learned this lesson again recently. I know mobile phones relatively well. I know that Palm has one of the best mobile phones... the Palm Pre. You use it for a few minutes and it just feels right. I show someone it and even if they have an iPhone, they say, "Wow, that's pretty cool!" So, my experiences told me that it was it wise to invest in Palm. Turns out that their marketing was pretty bad, and their exclusive agreement with Sprint went on a month too long. By that time, Verizon decided to put its promotion power behind the Motorola Droid. While I thought I was investing in what I knew, it turns out that I wasn't. I wasn't investing in the product only, but also the marketing and the company's business execution.

As you can tell, I'm a little skeptical about the strategy of investing in what you know. In the next day or two, in part 2, I'll expand on this topic as well as give more details about the company and their product. In the meantime, let me know in the comments if you invest in what you know or if you are skeptical like me.

Posted on July 27, 2010.

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16 Responses to “Invest in What You Know? (Part 1)”

  1. John says:

    But the key thing is Peter Lynch said “Finding the promising company is only the first step. The next
    step is doing the research”. Funny you mentioned Warren Buffett, because in the commentary to Chapter 5 of the updated The Intelligent Investor (his most recommended book), they address this issue.

    • Lazy Man says:

      I’m still skeptical about that next step. For instance in the Palm case, it was not public knowledge how long the exclusive lock-up with Sprint was… or whether Verizon would put it’s muscle behind the Palm Pre or Motorola Droid. It seems that much of the research is not publicly available information.

      I should probably put The Intelligent Investor in my PaperbackSwap.com queue.

  2. This is why I don’t invest in technology companies. They might have a great product today, yet one year from now the product is not “cool” and even worse, obsolete.

    Everyone says how Apple is successful today. But few remember that in 1997 the company was in a very tough position. Some macheads even worried that AAPL would go under in 1997…

  3. Anonymous says:

    I now prefer to invest in companies that I watched for a while in how their stock behaves. I also want to understand if the product they are selling is in demand.

    There is an interesting thing called “familiarity bias”. If you look it up it will explain why we invest in what we know.

  4. bb says:

    Invest in what you know – that includes analyzing its moat (aka competitive advantage in terms of marketing).

    The tech sector favors the biggest players as it’s not about the best products but about the marketing power.

    Think long-term if you’re an investor. Track record doesn’t mean all but it’s at least a good indicator. Palm? Its history tells me it sucks.

  5. Lazy Man says:

    I buy what you are saying bb, except that Palm’s history is extraordinary.

    Palm was the most successful PDA company and very much invented the concept of the smartphone (which I will loosely define as a cellphone with a touch screen, access to PDA functions, calendar/contacts/etc, and Internet functions, email/web, etc. as well ability to run third party applications.)

    In contrast, Apple’s history was very much in question before it put all its eggs into design… something that is still considered a strong point for the Palm Pre.

  6. bb says:

    You’re right it’s a successful “PDA” (who still use that term?) company but it failed to see the convergence of cell phones and PDA. It also failed to keep corporate customers happy, then Blackberry has taken over.

    The major reason for Apple’s success was the networking effect of iTunes/apps and its “closed” Windows-like platform – You can’t use other software to play iTunes files, and you also can’t use apps on non-Apple devices. That’s the moat.

  7. Lazy Man says:

    Palm was the first company to converge a PDA and a cell phone (the Treo back in 2002).

    It never had the corporate customers that Blackberry had. Blackberry had Exchange and push integration of email, which was the killer feature that got people addicted to Blackberries.

    I was giving Apple’s success all the way back to the color iMac “bubble” desktops (not sure what to call them) as well as the originally well-designed iPod. That design is what got them critical mass enough to build iTunes in the first place.

    I’m pretty sure that you can buy iTunes music without DRM… so there’s no real moat there. Now the moat is in the number of applications with the iPhone and possible the number of accessories that are designed to work with it.

    I don’t think the applications is a very big moat. Developers who have never had a Palm device can port their games from iPhone to the Palm Pre in a matter of 2.5 days: http://www.philhassey.com/blog/2010/07/14/porting-to-palm-webos/.

  8. Al says:

    I think you knew a lot about the device but not enough about the manufacturer. More industry & company research was needed. Sure Palm was great in the 90’s but recently they were running third in a two horse race.

    Tech industry critics, analysts & pundits were all in agreement that the Palm was in bad shape prior to the Pre being released. The Folio was canned and the Pre had been delayed many times. Back then RIM & Apple were eating Palm’s lunch. The Pre was successful but not enough to alone make Palm profitable. And that was all before Android really got popular.

    Yes, the Pre was successful (your experience) but it was a matter of Palm doing too little too late in the industry. Plus the Pre was really the only horse in the Palm stable. Apple had many products (Macs, iPods etc), RIM had many models as did as other industry players. Those manufacturer’s could afford to make mistakes; Palm couldn’t. The Pre was a home run for Palm. Unfortunately they were down by 3 runs and needed a Grand Slam to survive.

    Today Microsoft is almost in the same position some 18 months later with their phone offerings. Windows Phone 7 really needs a big hit to survive. The difference is Microsoft is a big diverse company and might be able to absorb a failure. Although they might fail in the phone market the company won’t go under.

    • Lazy Man says:

      Well, the Palm Treo was still a market leader before the iPhone came out in 2007. So I don’t know if I’d go all the way back to the 90’s.

      I don’t remember the Pre being delayed at all. Perhaps the webOS that was to replace the PalmOS was delayed, but I don’t know about the Pre. When the Pre came out on Sprint, it was a one horse race with that one phone being locked to one carrier (as you noted Android wasn’t popular). Palm had a history of being available on multiple carriers.

      Android didn’t get popular until the Motorola Droid. And as of March of this year, this sample of 30,000 votes had the Palm Pre better than the Droid by a factor of 2 to 1: http://blog.laptopmag.com/march-smart-phone-madness-finals-motorola-droid-vs-palm-pre-plus. Earlier this month the Palm Pre beat out the Droid Incredible: http://blog.laptopmag.com/htc-droid-incredible-vs-palm-pre-plus.

      While I see what you are saying about RIM having many models, they are similar to old Palm Treos… they are a dying brand who needs generation operating system yesterday. For this reason, the Pre is ahead of that RIM curve. Apples more products isn’t always a good thing. In fact, that’s what you are looking at, you’d think that Palm (as part of HP) will blow Apple out of the water. HP has a lot more products and sells a lot more computers.

      Also, when investing, remember that where you start matters. If your marketcap is small like Palm’s was even a little success means that it goes up a lot. If you invested in January (or so) of 2009 and sold at the end of the year you’d have made about 15x your money. I would be hard to imagine Apple or RIM growing their share prices by 15x.

  9. bb says:

    I guess its 2009 performance alone can’t imply you can invest in it over the long-term (see 2010). Where you start matters, where you end also matters.

    After all, it’s also about timing. Nobody would have cared about iPhone or iPad if it were introduced in 2002, either.

    Palm might have introduced a PDA+Phone years ago but it wasn’t user-friendly enough to attract consumers (Apple’s hand gesture interface) or useful enough to corporate users (Blackberry’s Exchange push as you mentioned).

    Don’t forget developers make money effectively by just posting the apps thru Apple’s App Store, the only channel. The biggest difference between Apple and Blackberry/Android/Palm is that Apple users can extend their apps/iTunes experience to different Apple devices (iPhone/iPad/Mac). Lastly, switching cost does matter to users (think Windows).

  10. Lazy Man says:

    To put things in perspective Palm had 17.8% of the market in August 2005. That’s more than Android’s share today and only a little less than Apple’s share: http://www.precentral.net/latest-comscore-numbers-show-palm-adding-subscribers-losing-market-share-remaining-top-5.

    So I don’t know if I’d say it didn’t attract customers. Apple’s hand gesture interface was a step forward, but I don’t think the same kind of touchscreens were available in the days of the Treo. Also, almost everyone I talk who has ever used a real keyboard avoids Apple because of the lack of a real keyboard.

    The Palm Pre has an App Store where developers can make money. I don’t know if you can count iPhone apps as being relevant on a Mac world. Apple’s approval process also upsets many developers, while Palm openly encourages people to jailbreak their phones: http://www.precentral.net/mckinney-we-support-homebrew-hp-engineers-creating-webos-apps.

  11. Sometimes buying what you know lends itself to emotional investing and irrational thoughts of expertise where none exists. You can’t really win. In most cases, you “think” you know more about the prospects of a company when in fact you don’t, and the analysts or hedge fund traders have better ways of assessing. On the other hand, if you truly have insider information and trade on it, you are subject to prosecution. And the most common situation I see is, employees “think” they have some great gem and trade on it when in fact it was meaningless.

  12. bb says:

    Back in 2005, the smartphone market was much smaller (about half of today’s). Palm started to lose its market share just when consumers had more choices (http://media.artdiamondblog.com/images2/SmartphoneMarketShareGrasphic.gif).

    You’re right, that’s why Palm started to fade right after the advanced interface was available. Obviously, average consumers aren’t like you or your friends.

    It’s all about money, Apple’s App Store has all the users and developers at one place, at least for now.

    We have only been talking about the product alone, don’t forget the company (the fundamentals) matters, too. The company has been operating at a loss since 2007… It sold its latest phones thru the No. 3 carrier – Sprint… About marketing, recall the last Palm ad (even if the product is good, you need to tell people about it)…?

  13. I think buffet was more about don’t invest in anything you don’t understand. Which is a little different, not much but crucial.

  14. Moneyedup says:

    I can agree with not investing in anything you don’t fully understand. Only investing in what you know could limit your investment choices to your area of work or something you studied in school.

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