For better or worse, Peter Lynch is the "buy what you know" guru.
Even though he's said he didn't mean that exactly, "buy what you know" is an incomplete guide to beating the market. It suggests that some of your best investing ideas will come by snapping up shares of companies behind your favorite products or by trolling the mall. And when I first read it as a 20-something investor, I embraced the simple notion of acquiring the familiar.
But it's not so simple.
The other half of "buy what you know"
The problem is that "buying what you know" is just the first step to beating the market. Once you take it up a notch -- going from One Up on Wall Street to what I will call Two Up on Wall Street -- you will realize that the second logical step is even more important.
That second step? The missing ingredient from Lynch's once-tantalizing investing recipe?
Buy what they don't know.
Calling off the Lynch mob
After all, I can live my life sipping Monster energy drinks by Hansen Natural (Nasdaq: HANS ) . It's good stuff. That doesn't mean that I will make a mint on the company. In fact, I probably won't at this point, because everybody already knows the Hansen story. The real money to be made in Hansen was several years ago, when the market figured that the soft drink giants would squash energy drink makers like Hansen and Red Bull.
So it's not necessarily about buying what you know. It's ultimately about buying what they don't know.
Some of my favorite investments -- and, I bet, many of yours -- have been companies that grew in popularity after they camped out in your portfolio. I bought TiVo (Nasdaq: TIVO ) before its recent run. It didn't hurt that I was one of its first subscribers.
The convenience of pausing and rewinding live television made perfect sense to me, even if I had to overpay to get one of the first digital video recorders. The rest of the country was fine with their VCRs. They came around. I am now one of more than 4 million TiVo subscribers, with countless more users of non-TiVo DVR systems.
Zig before they even think of zagging
As a member of the Rule Breakers newsletter team, I try to spot emerging trends early, to try to profit from being early to the party. David Gardner's newsletter is all about buying what they do not know.
Chipotle (NYSE: CMG ) shares have more than doubled since I recommended the stock to newsletter subscribers earlier this year. The fast-growing burrito shop has had a great run, but how much of that has come at the expense of skeptics who felt that the company would fail the way that CKE Restaurants (NYSE: CKR ) and Wendy's (NYSE: WEN ) failed to grow their quick-service Mexican food eateries?
In that time, Chipotle has rattled off double-digit gains at the store level with explosive profitability. With so much of the investing public either ignorant or cynical when it comes to the power of a hot concept with plenty of expansion room to run, investors should continue to profit from buying what the rest of the market doesn't know.
Akamai Technologies (Nasdaq: AKAM ) is another of the market-thumping picks for Rule Breakers. The content delivery network is the leader in delivering music, video, and cached web pages to Internet surfers. An onslaught of price-slashing competitors like Level 3 Communications (Nasdaq: LVLT ) have made things difficult for Akamai lately, but the shares have still more than doubled since being initially singled out. I knew about Akamai when Tim Beyers recommended it. The real kicker is that most investors didn't -- and still don't -- know it.
Buy what you know better
When you invest, go to the mall; ponder the contents of your cupboard; question why you chose one burger joint over the other. And when you unlock that desire to be inquisitive about equities, also figure out what you know -- and what you see -- before the rest of the market.
That's what we do at Rule Breakers -- and you can sign up to see our picks today by clicking here with no obligation to subscribe.
This article was originally published on Nov. 2, 2007. It has been updated.
Longtime Fool contributor Rick Munarriz wonders whether Peter Lynch will ever read this article. He still owns shares in TiVo. Chipotle has also been recommended to Hidden Gems subscribers. The Fool has a disclosure policy.