When "Buy What You Know" Goes Terribly Wrong

Back in January, I tackled the Peter Lynch thesis that you should "invest in what you know," and I came to the conclusion that buying what you know works against the investor by vastly limiting his or her possible investment choices. Today I aim to tackle this topic once again, but this time from a completely different angle -- and you can thank Twitter for that.

Don't be a twit
Last night, I finally came to the conclusion that I am powerless over my social-media addiction and decided to join Twitter. As with Facebook, I can see why users can get so caught up in the hype that is social media, but just because I use the product, that doesn't mean I'd buy into its business model.

Because Twitter isn't a publicly traded company, we don't have easy access to its balance sheet, but based on the data at secondary-market exchange SharesPost, Twitter's current implied valuation is a staggering $9 billion. Keep in mind that this is a company that, according to eMarketer, is on track to bring in just $140 million in revenue this year and is only marginally profitable at best.

But it's GM!
The same can be said for big-name companies that have been around a lot longer than Twitter but have taken their shareholders for a wild ride. From old-economy companies General Motors (NYSE: GM  ) , Eastman Kodak (NYSE: EK  ) , and Xerox (NYSE: XRX  ) to mobile-savvy Sirius XM (Nasdaq: SIRI  ) and Nokia (NYSE: NOK  ) , investors may have purchased any of their stocks because they used and liked the company's product -- only most found out too little, too late, that a good product doesn't necessarily translate into a good investment.

To add another aspect to the story, buying what you know involves not only expanding your horizons beyond a handful of companies, but also putting your emotional attachment for products aside and considering how suitable a stock would be for your investment style. As cliched as that may sound, it makes a lot of sense. Just because Yahoo! is my preferred search engine, that doesn't mean I can forgive the company's directionless growth model over the past few years.

Sometimes you have to be cruel to be kind
Only when you can objectively examine a company beyond your attachment to its products can you fully call yourself an investor in the business. Until you can do that, blindly following Peter Lynch's advice has the potential to get you in quite a bit of trouble.

What companies have you purchased just because you liked a product, only to be taken to the woodshed by reality? Share them in the comments section below.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He feels lonely having only eight Twitter followers, so feel free to add him (yes, that was a shameless plug). You can follow him on CAPS under the screen name TMFUltraLong and on Twitter, where he goes by @TMFUltraLong. The Motley Fool owns shares of Yahoo! Motley Fool newsletter services have recommended buying shares of Yahoo! and General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy


Read/Post Comments (3) | Recommend This Article (5)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 14, 2011, at 1:05 PM, jerr1 wrote:

    Good article most of facts are correct. One thing that i see happening to the stock dropping in 30 percent blocks . Latest was stock down to 1.17. I can see steady decline in price or value added.Current reveiw quartly results come out nov 3. By that time stock should be around .13 cents at current rate decent. Which would be good time for company to repurchase those out standing stocks for penny on dallor. Im long for kodak once i buy in at .13 cents

  • Report this Comment On October 14, 2011, at 2:20 PM, ikkyu2 wrote:

    I got taken to the woodshed by GM. I averaged down from 36 to 15, then got out at $2.

    I remember lifting an eyebrow when GM posted a $68 billion quarterly loss. No analyst commented and no change in the stock price that week; it was written off to an 'accounting change.' 9 months later the company was bankrupt.

    There are Pontiacs and Cadillacs - old and newer ones - in my garage and they were tangible evidence of the history of quality products that consumers were slavishly devoted to. My thesis was, "But it's GM!" and that eventually an economic recovery would buoy the company's fortunes.

    Valuable lesson. Now, when I can't understand the balance sheet (even with access to the Goldman Excel spreadsheet - which I had) I don't hold the stock.

  • Report this Comment On October 14, 2011, at 9:39 PM, duze54 wrote:

    I don't know why you lump Sirius in with old companies that did well for investors early-only of late (10 or so years have they dropped). SiriusXM is technically a new company with #1 status in their niche. and CF is growing since it merged. This is a great product with a future for those who are in their cars alot. I will never listen to terrestrial radio again and I don't Pandora as I like the music offerings on Siri, but especially like the sports and talk-no one else has. And if terrestrial stations start signing on like Dish TV we'll see more people put it in.

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