For better or worse, Peter Lynch is the "buy what you know" guru.
Even though Lynch has said that 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 from snapping up shares of companies behind your favorite products, or by trolling the mall. And when I first read it as a twentysomething investor, I embraced the simple notion of acquiring the familiar.
But the strategy's not so simple.
The flip side
"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'll 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 sing the praises of Hewlett-Packard (NYSE: HPQ ) . Two of the three desktops in my home are HPs, including the one I'm using to peck out this article. I bought an HP printer earlier this month. That doesn't mean I'll make a mint on the company. In fact, I probably won't at this point, because everybody already knows the HP turnaround story.
The real money in Hewlett-Packard was made several quarters ago, when Carly Fiorina was unceremoniously booted from the helm and Mark Hurd took over. He cut through the clutter to deliver a streamlined company with gradually improving margins. HP has gone on to smoke Wall Street's numbers during every single quarter since Hurd took over. There was little reason to doubt his eventual success, given that he'd done the exact same thing at his previous gig.
Buy what no one else sees coming
Some of my favorite investments -- and many of yours, I bet -- have been companies that grew in popularity after they camped out in your portfolio. I bought Cedar Fair (NYSE: FUN ) several years ago, after realizing that my family vacations kept finding their way back to the company's flagship amusement park in Sandusky, Ohio.
Cedar Fair may be out of favor at the moment, but a chunky yield is rewarding my patience. The company has also been acquiring smaller parks and upgrading their fiscal performance to Cedar Fair standards. I have a healthier vision than the rest of the market regarding the future earnings potential of successful regional amusement parks. I'll just bide my time, enjoy the coasters, and ride them both out.
The leisure industry is always ripe for a revolution. Parks are just starting to embrace the appeal of digitally delivered in-park snapshots, and following Great Wolf Resorts' (Nasdaq: WOLF ) lead with indoor waterpark resorts that have year-round appeal. The industry may be slumping right now, but I'll stick with my rosy view of the future, rather than today's gray outlook.
Zig before they even think of zagging
As a member of the Rule Breakers newsletter team, I try to spot emerging trends early, to profit from being early to the party. David Gardner's newsletter is all about buying what they do not know.
NetEase.com (Nasdaq: NTES ) shares are up nearly 40% since I recommended the stock to newsletter subscribers a couple of years ago, more than tripling the S&P 500's gains in that time. The leader of online games in China is cashing in on the popularity of a booming economy and a young, diversion-hungry population's migration to cyberspace.
It may seem like an obvious play, especially now that NetEase is joined by other public players like Giant Interactive (NYSE: GA ) and The9 (Nasdaq: NCTY ) in this growing niche. Getting in early is the key.
BioMarin Pharmaceutical (Nasdaq: BMRN ) is another of Rule Breakers' market-thumping picks. Shares have more than doubled since being singled out last year. Like most biotech winners, getting in early on the company toiling away on cures for rare genetic diseases has been the key to big gains.
BioMarin is still early in its growth cycle. The real kicker is that most investors didn't -- and still don't -- know about BioMarin.
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, figure out what you know -- and what you see -- before the rest of the market.
That's what we do at Rule Breakers. You can sign up to see our picks today by clicking here, with no obligation to subscribe.
This article was originally published Nov. 2, 2007. It has been updated.
Longtime Fool contributor Rick Munarriz wonders whether Peter Lynch will ever read this article. Rick still owns shares in Cedar Fair, an Income Investor recommendation. The Fool has a disclosure policy.