By Elyse Andrews
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Investing in What You Know
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I was browsing through our Web site archives this week and ran across a
Cabot Wealth Advisory written by Editor Brendan Coffey in August of last year.
In it, he discussed the concept of buying stocks based on what you know ...
and what you like. Here's what he said:
"Throughout the 13 years he was steering the Magellan Fund, Peter Lynch
became known for his philosophy that you should invest in what you know.
In his 1993 book, "Beating the Street," he discussed how he built Magellan
from a $200 million fund to a $14 billion fund in a little more than a
decade. The philosophy Lynch wanted to drive home to individual investors
was that you should buy companies that you are familiar with. In Lynch's
case, he liked the "tasty tacos of Taco Bell," so he added the
then-unknown chain into the portfolio; his wife loved the convenience of
L'eggs hosiery, so he bought shares of Hanes.
"Buying what you know has long since become a bit of Gospel among a large
segment of investors--after all, if it worked for Peter Lynch, it should
work for you. It's not a bad idea--certainly if you feel strongly about a
company and have what you think is pretty decent insight into its products
and market, then you can do all right. I know a few creative types who did
quite well buying Apple Computer stock when it was well under 20 in the
late 1990s."
I took this advice to heart after reading the June 1 issue of Cabot Top
Ten Report, which featured on of my favorite stores: J. Crew (JCG). In
that issue, Editor Michael Cintolo wrote:
"J. Crew is one of the market's strongest stocks because its bottom line
is coming in much better than expected, and analysts are tripping over
themselves to hike earnings estimates. J. Crew reported earnings last
week, and while the year-over-year numbers were nothing to shout about (it
squeaked out a small revenue gain but earnings fell 29%), the bottom line
was more than triple what analysts had expected. The reason: Solid
margins, which we believe is because of top-notch management--the company
has a history of outperforming its peers, and while that didn't mean much
during the last year, it will as the economy picks up. Analysts hiked
their 2009 earnings estimates from $0.47 to $0.82 a share after last
week's report, and considering J. Crew has beat expectations the past
three quarters, we believe even these newer estimates are conservative.
It's an interesting turnaround situation."
Mike put the suggested buy range at 24 to 27 and I picked it up at 26 for
my Paper Portfolio at work (not real money, just a little office
competition) and as of press time, I'm sitting on a 20% profit. JCG isn't
your typical growth stock, but I like the company and the clothes, so I'm
going to hold on a little bit longer. It's back-to-school shopping season
and the store, with its classic styles, is bound to see an uptick in
spending from that.
However, I also have a word of caution from Brendan's write-up last year
about Lynch's philosophy and I'll share it with you here:
"But it's possible to take buying what you know too far. It's one thing to
rely on your gut feeling, but another to let it overwhelm your intellect.
Peter Lynch, after all, wasn't a Forrest Gump-like fund manager, blindly
lucking into gold because he liked the taste of nacho cheese. He liked the
underlying business of Taco Bell, the balance sheet, the management and
the growth plan. It certainly helps that the company had a simple story to
tell--it prompted Lynch to take a deeper look at the business structure
and the stock valuation.
"But a lot of other food chains have had simple stories, even better food,
but everything from poor management to a too-high debt burden to
unrealistic growth plans did them in. That's a lesson Peter Lynch also
discusses in his book, but because it isn't so pithy, it doesn't get
repeated very often. There is a difference between a good company and a
good stock. One can be the first, but that doesn't mean it's the second."
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