Investing in What You Know
Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
A lot of people start investing with what they know, so the title of this post may seem a bit redundant or too obvious. However, I'd like to break down the positives and negatives associated with this tendency we all have that novice investors are the most likely to surrender to. We all like familiar things. However, that's not a good reason to buy a stock. Shares of companies need to be bought because they will grow your wealth, not just because you recognize what the company does.
In the case of Facebook (NASDAQ: FB), a lot of investors got burned on the IPO. It's a tragedy that investment bankers chose to stir up as much hype as possible for this stock despite its uncertain business model and the inherent difficulty of valuing any company that does not produce something tangible. However, I have heard it stated that Facebook now offers a payments system known as Facebook Credits. These will essentially force you to pay for a synthetic form of currency in order to buy things that exist only in Facebook-world, or whatever their big games are called.
As anyone who's ever used Blackboard, AT&T or almost any tech company can attest, having more rules and being a more generally annoying company is ultimately very good for the share price. If you want to buy Facebook as I eventually do, wait until the early speculators finally accept the loss and sell Facebook until it hits single digit territory. It usually happens when people finally give up on making a huge, immediate profit, just like it did when the Dot-Com Bubble burst. Then hold on, hold on, for the love of Amazon hold on. Like Amazon's fall into the single digits, Facebook's will be temporary because its business model is solid, its cash flow is steady and growing and its inexperienced management will get better. I can see Facebook struggling as Yahoo has to re-find its purpose in an online environment that will pass it by for a time as social networking inevitably changes again. Between 5 and 15 years from now, I see Facebook pulling a recovery that would make Apple nod respectfully. Just don't buy it right now unless you want to sell it to me later for a price I'll enjoy and you won't.
Remember when Apple just made computers and people were practically giving away its shares? Am I sounding old yet?
Another option familiar to most people who have a lawn is John Deere (NYSE: DE), the makers of tons of lawn and farming equipment. While I personally use a McCulloch, I admit that when I occasionally check the toy section of Wal-mart to see what's big, I have not once seen Mac on the side of a box with a little cartoon character happily mowing along. You will see John Deere toys, though, which means this is a serious brand. If you're looking to add a manufacturer to your portfolio that has nothing to do with computers, this might be your horse. 'I'll Have Another' is a perfect allusion to reinvesting John Deere's dividends, which have risen steadily since their low during the market crash of 1987. While John Deere is a good company that's trading at an earnings multiple under 10, it's still not that great of a deal. If your priority is to hold for a long time and let dividends slowly grow your wealth, John Deere's a solid bet. But if you're looking for something that moves a bit faster, pass up this good old boy.
Perhaps the most familiar company to food addicts like myself is McDonald's (NYSE: MCD), purveyors of foods we know we shouldn't eat but just can't stop occasionally indulging in. Unless the federal government risks another Boston Tea Party by outlawing high levels of saturated fat, Mickey D's is going to be around for a long time. Considering the massive profitability this restaurant chain experiences and the fact that its business model reinforces itself by making most stores sink or swim on their own management, not to mention the company's high sales growth levels in Asia, familiarity breeds long-term profit. The downside to the golden arches is, like every company I've mentioned in this article so far, the Achilles heel of any familiar company -- everybody knows about it and sees it as "safe," so the multiples aren't great. When last I checked it was in the 17 p/e range, which doesn't excite my inner deal-seeker in the slightest. In short, I would suggest you wait for a better time if you want to buy McDonald's.
If you've had enough burgers and lawn mowing and want to get some office work done, Microsoft (NASDAQ: MSFT) is a pretty solid option. Yes, its dominance in the PC market is being challenged by tablets and smart phones. Indeed, the original Mr. Softy himself has sold a large amount of shares over the past few decades and diversified into holdings like Waste Management. The company even recorded a loss for the quarter; the first time since it has been public. Man, this is starting to sound like a Rocky movie.
Microsoft has some positives working for it beyond mere brand recognition. The same people who dominate the world on the PC are working on Windows 8, looking to jump Apple on the tablet and smart phone side of things and make Windows the most integrated operating system in world history. No word yet on whether their next trick is to reach Mars on a surf board, but that would also be pretty cool. Bill Gates's sales of shares are nothing new, and I was only using that information to build dramatic tension. Finally, the best reason why Microsoft is still in the game is that its quarterly loss is not that big a deal. While losses are bad, this loss isn't some systemic problem. It was a bad bet the company made that it is now writing off almost entirely.
This means that perhaps for the first time in more than a decade, you could pick up some inexpensive shares of Microsoft in the near future. As I write this I'm considering doing so once the Fool's rules permit me to. While you'll have to be gutsy to fight off the secondhand shouts of, "Microsoft is losing money! Don't buy it!" you may be handsomely rewarded. Remember when Apple didn't have all those i-things... and just made computers... and was trading cheaply on losses?
The main point I want to get across here is that you have to use your brain and your guts if you're going to buy stocks for any reason other than the unique hobby of saying, "Yeah, I own shares of that" when it comes up at a party. Don't buy a stock because you know its name and its products. Buy because you know its business, and more importantly what will make that business more or less effective in the future.
pongun has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook, McDonald's, and Microsoft. Motley Fool newsletter services recommend McDonald's and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.If you have questions about this post or the Fool’s blog network, click here for information.