Invest in what you know or what you don’t know?

Most companies I’ve invested in have been ones that I wasn’t previously familiar with. I only became familiar with the product and industry after many hours of research. This isn’t on purpose—just a result of me not being a user of most public company’s products. The advantage of this is that I approach learning about these new products from a clean slate with few biases. The drawback is that I will probably never understand the product as well as I would if I was a regular user.

The opposite of this is Peter Lynch’s investing style: “Invest in what you know.” Lynch advised people to invest in companies they know and love. Logically, this makes a lot of sense, but I’m not convinced this method is any better (or worse). The advantage of Lynch’s approach is that a user might have a unique insight into the value of a company that other investors may not have or appreciate. The drawback is the user will almost certainly overemphasize their own experience with the company and may discount what the greater population thinks (i.e. the base rate).

Over the past year, I’ve been following some of the big American tech companies more and it’s made me realize how strong my biases are with public companies when I use their services on a regular basis. Whether I like what the FAANG companies sell has a massive influence on how I view one of them as a potential investment, and I don’t think that’s a good thing. My personal hot takes on FAANG:

  • Facebook: Not a big fan of social media and wish people would get off their phones more often (get off my lawn, I know). I don’t use WhatsApp, Messenger, or Instagram, and I only use Facebook for events.
  • Apple: I used to have several Apple products and they eventually drove me nuts. Transitioned everything to Google and not going back anytime soon. Just the lack of a back button on my girlfriend’s iPhone is now enough to drive me up a wall.
  • Amazon: I’m probably Amazon’s ideal customer in that I only price compare on items that are several hundred dollars+ and I despise in-person shopping so that’s not even an option. The convenience is worth knowing I’ll overpay on some stuff.
  • Netflix: meh. I’ve had it for a long time because it’s free (thanks family 😊), but I wouldn’t pay for it. Movies suck, standup / documentaries are solid, TV shows are more miss than hit. I watch Amazon Video significantly more often.
  • Google: I’m also an ideal Google customer. I love Google, Gmail, and Chrome, subscribe to Google Play and YouTube Red, own an Android phone, and rely on Google Drive as my life’s backup.

Here’s the problem: Facebook, Apple, and Netflix are pretty fantastic businesses, but subjectively I’m not a big fan. I recognize that Facebook is an advertiser’s wet dream, but as a user, I wouldn’t care if all their services disappeared overnight. And that’s a difficult gap to bridge. As a potential investment, I would almost certainly like Facebook more if I had zero experience with any of their services. Thus, from an investing standpoint, I’m actually worse off being a Facebook user than I would be if I had zero experience with it.

On the opposite end of the spectrum, I’m probably very likely to overrate Amazon and Google because my experiences with them are far above the base rate (you’ll never guess the two companies from the above list that I follow the closest!).

When I invested in Fogo de Chao, part of my thesis was how impressed I was by the quality of food when I ate there for the first time. Looking back, I don’t know if that was a good thing or not. Luckily my taste and opinion lined up with Yelp reviews and everything else I had found. However, if my view of their food differed from the Yelp reviews, I probably would have overrated my own opinion.

As I’ve been thinking about this stuff lately, I went back through my notes from Thinking, Fast and Slow and recognized a couple biases that are affecting me.

I think the main one in play is the availability heuristic, which claims that humans judge the frequency of an event by the ease with which instances come to mind. The classic example is a recent plane crash that makes headline news and results in people way overestimating the dangers of flying. The relevant aspect of this heuristic is that personal experiences are the most available experiences we have. I can look at the data and see that two billion people use Facebook and judging by how many hours they spend on it, the platform is obviously well liked. Nonetheless, if someone asks me about Facebook, my first thought is still more likely to be “I don’t enjoy Facebook, so it’s not a good platform.” It’s very difficult to overcome those innate, visceral opinions of a brand or business.

That reaction of mine plays directly into the next bias: substitution. Human brains subconsciously substitute easier questions for more difficult questions. “Should I research Facebook as a potential investment?” might be the question I ask myself, but the question I subconsciously answer is “Do I like Facebook?” Not surprisingly, I have yet to do a deep dive into the company.

It’s so easy to jump straight to my own anecdotal evidence when thinking about a company that I’m familiar with, but my own experiences really aren’t very relevant. There are cases where users can have unique insights, but more often than not I see investors who overemphasize their own experiences with some product or service. The large data that shows the base rate is what matters, not one person’s subjective, biased opinion.

The only company I own and regularly use the product of is Interactive Brokers. Not surprisingly, I’m a very happy customer. However, I can’t tell you how many investors have told me they’d never invest in Interactive Brokers because of how terrible their customer service is or how difficult the interface is to use. I got used to the interface in a week or two and have had almost universally positive customer service experiences—and those two things certainly played a role in my original investment.

On the other side, I don’t recall investing in a company where my opinion of their product or service differed wildly from the popular opinion. I’d like to though. Not just for the sake of it obviously, but it’d be good to know that I can set aside my own biases when the popular opinion is different than my own.

As of this writing, Wiedower Capital owns shares in IBKR. This is subject to change.

One thought on “Invest in what you know or what you don’t know?

  1. Great post. I was quite surprised to see that part in his book, maybe he is trying to make investing “easier” for average people (dangerous if that was the case). I saw in one of his interviews later he clarified that this WAS NOT what he meant, meaning people should not invest in something because he/she like the product. 🙂

    Like

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