Should I buy stock in companies I know?

Nanotechnology companies sound cool. Some biotechs have earned big bucks for investors. Maybe you’re considering making your fortune by investing in offshore oil wells or even marijuana sales.

With so many industries to consider, it’s common for investors to ask the question: Should I buy shares of exciting-sounding companies (even if I don’t entirely understand what they do or how they make money), or should I buy stock in companies I know?

In general, we side with legendary mutual fund manager Peter Lynch:

“If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won’t get bored.”

‘Buy what you know’

Lynch advocated the concept of buying what you know. The investing legend felt that if individual investors (like us) would focus on their own field, they could have advantages over Wall Street professionals.

Consider the competitors or the suppliers for the company where you work. If you eat at the same restaurant three times a week, maybe dig into the investing case for that company. If you’re the first to buy all the latest gadgets, consider exploring an investment in one of the companies that’s making the coolest toys.

Use the knowledge you have to inform your investing, at least as the starting point for your investments.

Know when to hold

As Foolish investors, we think that the best way to profit from stock market is to buy to hold a company for years or decades to come.

As Fool co-founder David Gardner wrote in the article linked above, “We are focused on the long term. Let the day traders work all day for their 5% blips here and there, and fret when the market sells off for a month. Boo-hoo-hoo. We play an entirely different game — a game measured by huge percentage points of profit, and counted in years.”

In this context, knowing a company well can prove to be a key prerequisite in successful investing. After all, if we understand the business behind the ticker, we stand a better chance of following the company’s developments over the long term. And if we can better understand the company, our chances of making the right investing decisions can improve over time.

That’s not to say that knowing a company alone will guarantee you investing success. Even if you know a company intimately, there can still be unpleasant surprises.

But in our opinion, you stack the odds in your favor if you know what to look for, what to expect, and what to beware of in your potential investments.

If you’d like to uncover a world of market-beating companies — whether in your expertise or not — we’re pleased to offer you a free trial to our flagship newsletter service, Stock Advisor.

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