Buy Stock in What You Know vs. Buy Stock in What Others are Buying

In the latest Kiplinger’s magazine, there was an article about investing that caught my eye: Spotting Winners at the Mall. It started out brilliantly with a great quote by Yogi Berra, “You can see a lot just by looking” and referencing Peter Lynch’s secret, “I began my search for new selections in the usual fashion. I headed straight for my favorite source of investment ideas: the Burlington Mall.”

Growing up the Burlington, MA was the closest mall to me and I spent a ton of time there. I wonder how many times I passed him there while Lynch was manager of Fidelity’s Magellan fund (which my mother invested in) from 1977 to 1990. I hope he didn’t follow me to the nearby Tower Records as that wouldn’t have been a great investment for him.

The article makes the point that you should look around and see what others are buying for your investment ideas. When I first read this article, I confused its message for Peter Lynch’s other famous advice, “Invest in what you know.”

Investing in what you know, can be, quite frankly, a terrible idea. I’ve learned this lesson the hard way a few times. Regular readers know that I was a big fan of Palm. It goes back to when they invented the smartphone (which I’ll define as being the first company to combine a mobile operating system with a cell phone). I grew more confident when they came out with their webOS product that had things like multitasking, advanced notifications, wireless charging, gesture navigation, and syncing of all your accounts (email accounts, calendars, contacts) into one view. Even today, Apple and Google are still “borrowing” from what Palm debuted in the summer of 2009.

I knew that once people used these features, they wouldn’t go back to any other operating system. At the time, you’d be hard-pressed to even find a Android device as it was months before Verizon started their “Droid” campaign.

It turns out that I didn’t know a number of things about Palm and HP who ended up buying Palm. There are two outstanding articles from Fortune and The Verge that give exception detail on how nearly everything that could go wrong did go wrong. Some of it, the average investor could predict, but most of it he/she could not.

The lesson: What you know may not be all there is to know.

But what about “buying stock what others are buying”, using the mall as an example? To some extent the Kiplinger article provides its own cautionary tale. It cites Lululemon Athletica (LULU) “that has a cultlike following, took a huge dive, from $82 to $61, during a two-week period in June—after the CEO resigned on the heels of the embarrassing revelation that a fabric used in Lululemon clothes was too easy to see through.”

Now, if you bought Lululemon at $82 on the basis of that cultlike following, you would have lost 25% of your money. Were you going to predict that the “see through” clothing would be a problem? If it were, why wouldn’t it stop the cultlike following dead its tracks years ago? Also, if you are going to be a buyer in the stock you’d have to be comfortable in the CEO and that the new opaque product is going to please the “cult.” As I write this, the stock has recovered to $72 leaving the investor still down ~12%.

The lesson here is the same as buy what you know: What you know may not be all there is to know.

For someone like Peter Lynch, I imagine these are starting points, the inception of an investing idea. From there, I bet he met with management and did all kind of research that the average investor simply wouldn’t have access to.

The more I think about it, the happier I am with index funds for over 90% of my portfolio.