Buying What You Know

There is a difference between admiring a company for its remarkable products and buying its stock

Ariel Investments LLC President Mellody Hobson

I think one of the most-repeated pieces of investment advice—“buy what you know”—can be quite problematic. Many people confuse what they see and hear with the type of hard-core knowledge necessary to make sound investment decisions. Take, for example, Apple and Facebook. Seemingly, everybody uses their products, is familiar with their rapid growth history, and can name the late legend Steve Jobs as well as “baby” CEO Mark Zuckerberg. Many may convince themselves they “know” these companies will continue to grow year in and year out.

However, stock valuations are not based on previous results, but on the future. The price of a stock is not based on what a company has done the past few years. It’s based on what people think the company will do over the next few years. Those investing in Apple and Facebook are generally “growth investors” who buy companies that have the capability to grow faster than competitors and the general economy. Yet, for companies such as Facebook and Apple, the reality can become “the bigger they are, the harder they fall.” That is, the higher the expectations, the more difficult it is to maintain the growth rate necessary to keep investors satisfied. This past summer these two remarkable companies were living proof of this axiom.

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