Investing In What We Know and Business Like Investing

Should You Buy What You Know?



Do you like this great investing book The Intelligent Investor ?



What is even more interesting is that billionaire investor Warren Buffett still continues to read this great book by Benjamin Graham and yet the great legendary investor still continues to learn from it!



Under the revised edition by Jason Zweig, Chapter 5, pg 125 (commentary on Chapter 5), there is this one interesting commentary:



Should You Buy What You Know?



Another excellent commentary in which Jason commented that the intelligent investor should not simply abuse any famous investment teaching. Take one of Peter Lynch's famous teachings "buy what you know", in which, Lynch teaches that one can outperform the experts if one uses their edge by investing in companies or industries one already understand. The next step is doing the research. In which accordingly to Lynch, no one should invest in a company, no matter how great its products, without studying its financial statements and estimating its business value.



So how does one abuse this great teaching?



Ahhh... according to Jason, many would only remember and adopt the very first part of the teaching, which is "buy what you know".



The next part of doing the research is sadly neglected by the investor!!!



How valid is this point? Have you seen it happened before? Were those 'investments' a success? Think about it...



Well, Jason puts it very nicely:



In short, familiarity breeds complacency. On the TV news, isn't always a neighbour or the best friend or the parent of the criminal who says in a shocked voice, "He was such a nice guy". That's because whenever we are too close to someone or something, we take the beliefs for granted, instead of questioning them as we do when we confront something more remote. The more familiar a stock is, the more likely is to turn an investor into a lazy one who thinks there's no need to do any homework. Don't let that happen to you.



Don't you agree?



Say you were a frequent flyer with Air Asia from day one and you are a firm believer in that business model. So should you 'invest' in Air Asia because you 'know' the business?



Well, if one had invested in Air Asia from day one (without doing the homework) since its IPO listing back in Nov 2004, such an investment would have yielded a terrible, terrible result considering the general market had enjoyed a remarkable bullish run since 2004.



The below picture shows Air Asia performance since its IPO.

This rather terrible performance from Air Asia is not a shocker for me because I was less than impressed with the way Air Asia gave overly optimistic IPO earnings projections. See Air Asia. And if the investor had done the extra homework, the investor should have clearly seen that perhaps the IPO was simply priced based on sky high earnings projections. Which ultimately means it's probably way overpriced!)

How about Business Like Investing?



Well did you know that fellow blogger, Seng, had once written a great piece on investing called Fundamental Analysis (Do give a good read!)



Let me contribute a bit on Business like Investing or as Ah Seng Kor calls it BA or Business Analysis.



Business like Investing.



Making logical investment decisions is always crucial to one's success in investing. And it has been said that when one invests in a stock, perhaps one should consider it as if one has been given the opportunity to be a part owner of the business itself.



And when one adopts such an approach in their investment, one is forced to make investment decision based on simple logical decisions, decisions which are focused mainly on whether they believe that the stock that they want to purchase, represent a truly quality business in which they would want to be a part owner of such a business.



In short, one should think of being one of the bossie owning the business!!



And logically, if I am gonna be a BOSSIE in THE business, doesn't it make sense that I want to own a really good business?



In all honesty, who would want to own a lousy business?



And how would you rate your chances of making money from an ordinary, average business?

And needless to say, one would seriously not want to be own business with partners who you do not trust. Folks who would most likely cheat you the very second you have your back turned against them?

Put it this way, when we buy any stock, what are we doing in reality? We are buying the 'rights' to be a shareholder of the company, right? And since by the virtues of being a shareholder of the listed company, aren't we virtually the partner or part-owner (in regardless of the size of the shares that we purchase) of the business?



As said by one famous investor, Warren Buffett,

• “Investment is most intelligent when it is most businesslike.”

"We select our marketable equity securities in much the way we would evaluate a business for acquisition in its entirety. We want the business to be one

• that we can understand;
• with favorable long-term prospects;
• operated by honest and competent people; and
• available at a very attractive price."

Let's look at a simplistic example.

Ass-u-me and imagine that I own a famous barn yard called, Moo Moo Cow. So

if I were to approach you with a real-life opportunity to make an investment and be my business partner in my barn yard business, what's the first few things that you would be reasoning out?



1. How do we rate this barnyard business?

Do we understand what this cow business is all about? How on earth does one make money in a barnyard? etc etc....



2. Show me the Moola! We then need to know how profitable the business is. This is where we look at stuff like earnings track record, cash flow, profit margins etc etc.

3. And then we need to know what's next. Knowing what has happened before is important but just as important; we would want to know about the long term business prospect of the barn yard business. Got future or not?

4. Business weakness and competitors?

Don't you want to know what's the weakness in this bard yard business? Are there any business competitors from any cousin cows?



5. Do you trust the owners?

Do you trust this moo moo cow enough to be a part owner of this business? Will I attempt to take advantage of you as a business partner by short-changing you in any which way possible? Do you trust me enough?

Do you think that this cow is competent enough to manage your money?

In short, it's all about corporate governance here.

6. And last but not least, how much?

How much is this investment in this barnyard going to cost?

What kind of returns are you looking at when you invest in my barnyard?



And these are some simplistic logical, commonsense rational issues that one would want to consider if one wants to be a business partner of a business.



And if this barn yard is really real and is listed in the stock exchange, when one invest in this cow stock, shouldn't one adopt the same businesslike approach as if one was buying an actual stake in the barn yard?

Here's an old blog posting based on this approach published a long time ago.

http://everything27.blogspot.com/2006/01/buying-quality-businesses-megan-part.html

Yes, if one had adopted the business like investing perspective, one would have never even considered investing in Megan!!

And here is an article posted on Wallstraits: http://www.wallstraits.com/main/viewarticle.php?id=1202