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How to Invest in What You Know

By Catherine Brock – Jun 4, 2020 at 8:00AM

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Ready to get started in stock investing, but not sure where to start? Here are three places to look for investable companies you can understand.

Peter Lynch is one of the most successful mutual fund managers of all time. Lynch ran Fidelity's Magellan Fund between 1977 and 1990, averaging a 29% annual return and regularly outperforming the S&P 500. You'd think he had a crystal ball hiding in his desk drawer, but his approach is anchored in a surprisingly simple concept: Invest in what you know.

Investing in what you know means choosing companies with products and business models you understand. That doesn't require you to have an MBA, though. Look to Ronald Read for proof of that. Read was a janitor with no formal financial education. When he died, he was worth millions, and it was because he'd been investing for decades in blue-chip companies whose names he recognized.

A woman researching on her laptop.

Image source: Getty Images.

Especially for novice investors, it's far easier to evaluate products and services you know versus those you don't. As a product user, you have an important perspective: You know when a product delivers on its marketing promises and when it doesn't. You already have an opinion on how that product adds value to your life, how often you'd buy it, and how much you're willing to pay for it.

Being familiar with a product or industry makes your investment more understandable, interesting, and relatable. Just imagine having to read up on mining operations or artificial intelligence if you have no prior experience or interest in those industries. In a haze of boredom, you may overlook or misunderstand important details.

Don't let that happen to you. Here are three places to find familiar and investable companies to add to your portfolio.

1. The products you buy and where you buy them

Think back over what you've purchased in the last two months. Or, even better, consider how your purchases have changed since the beginning of the year. Through the coronavirus pandemic and the Great Lockdown, you may have shifted to stocking up on basics such as toilet paper, household cleaners, and canned foods. That's a hint to the types of products that are more resilient in recessions.

Look at the labels of the products you're buying and then research the manufacturer. You may find that many are made by Proctor & Gamble, Colgate-Palmolive, or Kimberly Clark. Or, consider the retailers that are selling you these products. Walmart, Costco Wholesale, and even Dollar General are all public companies, too.

2. The industry in which you work

Your professional expertise might be a source for investment ideas as well. Perhaps you're a software engineer who specializes in server setup and administration. You might be working daily with Amazon Web Services by Amazon (AMZN -1.57%), Azure by Microsoft (MSFT -1.94%), or Google Cloud Platform by Alphabet (GOOG -1.98%). As a professional user, you know the strengths and weaknesses of these platforms, you follow industry trends, and you're current on the latest solutions and features. You're better equipped to invest in the cloud computing sector than, say, an English teacher who only saves documents on a thumb drive.

On the other hand, a book publisher such as Scholastic might be a more interesting pick for that English teacher.

3. Your hobbies and interests

Your hobbies and subjects that generally interest you can also point you to investable companies. Here are a few examples:

  1. Love to garden? BrightView Holdings is a publicly traded landscaping company. Or, there's Home Depot (HD -0.86%) and Lowe's (LOW -1.39%), which both supply DIY and professional landscapers. These would also be appropriate options if you're a home improvement enthusiast.
  2. If you like cars, look at automakers, auto retailers, and aftermarket auto parts retailers.
  3. If fitness is your main hobby, you could research gym equipment manufacturers, sporting goods retailers, and even fitness apparel brands.

Don't skip the research

Investing in familiar products and services is not a substitute for researching companies, making logical choices, and tracking performance over time -- all practices followed by Lynch, Read, and every other thoughtful investor. Investing in what you know will make that research more meaningful and, hopefully, more fun. You stand to be most successful when investing (and the work it involves) becomes one of your hobbies, too.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Catherine Brock owns shares of Dollar General, Microsoft, and Procter & Gamble. The Motley Fool owns shares of and recommends Alphabet (C shares), Amazon, Home Depot, and Microsoft. The Motley Fool recommends BrightView Holdings, Inc., Costco Wholesale, and Lowe's and recommends the following options: long January 2021 $120 calls on Home Depot, long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2021 $210 calls on Home Depot, short January 2022 $1940 calls on Amazon, and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

The Home Depot, Inc. Stock Quote
The Home Depot, Inc.
HD
$275.94 (-0.86%) $-2.39
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$232.90 (-1.94%) $-4.60
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$113.00 (-1.57%) $-1.80
Walmart Stock Quote
Walmart
WMT
$129.70 (-1.93%) $-2.55
Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
$472.27 (-1.40%) $-6.71
Lowe's Companies, Inc. Stock Quote
Lowe's Companies, Inc.
LOW
$187.81 (-1.39%) $-2.65
Kimberly-Clark Corporation Stock Quote
Kimberly-Clark Corporation
KMB
$112.54 (-2.12%) $-2.44
The Procter & Gamble Company Stock Quote
The Procter & Gamble Company
PG
$126.25 (-1.90%) $-2.45
Dollar General Corporation Stock Quote
Dollar General Corporation
DG
$239.86 (0.16%) $0.39
Colgate-Palmolive Company Stock Quote
Colgate-Palmolive Company
CL
$70.25 (-2.12%) $-1.52
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOG
$96.15 (-1.98%) $-1.94
Scholastic Corporation Stock Quote
Scholastic Corporation
SCHL
$30.76 (1.72%) $0.52
BrightView Holdings, Inc. Stock Quote
BrightView Holdings, Inc.
BV
$7.94 (0.51%) $0.04

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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