Forget "buy what you know", and search out new ideas.
Last week, another investment pundit urged the public to "buy what you know, the businesses you see around you every day that are expanding and thriving". And yes, I know that this is classic Peter Lynch, and he's vastly more successful than I am, but I still cringed.
Do you know as much as you think?
A big problem with this approach is that we often don't 'know' as much as we think we do. Being able to tell a good sandwich from a poor one, and having firm opinions on the quality of the in-store lighting, doesn't make anyone an expert on the value of Marks & Spencer (LSE: MKS) shares, for example.
It's a characteristic of the retail and hospitality industries that people think they understand them and have a 'feel' for them, and this applies to entrepreneurs as much as to investors -- the current requirement to be 'passionate' about your product means people would rather open a loss-making bistro than a profitable paper-clip factory.
So ask yourself, what do you really know about the drivers of profit in these businesses that you see around you?
Consider the banks: Many thought the likes of Lloyds Banking Group (LSE: LLOY) and Royal Bank of Scotland (LSE: RBS) they were still run on the simple old 3-6-3 principle -- borrow at 3%, lend at 6%, and be teeing-off 3pm -- and they got a rude awakening. It turns out that even the guys who ran the banks, whose job it was to evaluate risk, didn't really have a grasp of it either, so what hope has the private investor?
And how many people take the additional risk of investing their pension pot in the company that employs them, because they think they understand it and it's doing well? And it may be doing well, but that doesn't necessarily make its shares a good investment.
Missing opportunities
The other major shortcoming of the buy-what-you-know approach is that the vast majority of companies on the stock exchange are names you'll never have heard of, satisfying needs you never knew existed. Obviously you'd need to acquaint yourself with those markets before buying the shares, but your knowledge can quickly be just as good as for a familiar business.
Remember, we're looking for what we believe to be pricing anomalies -- shares that are cheaper than we think they should be and will be -- and to find those we have the cast our nets as widely as possible. The familiar is no more likely to be mis-priced in our favour than the obscure, and that means we have to look beyond the obvious and consider the entire universe of shares available to us. And possibly learn something in the process.
How to find them
You can get plenty of ideas from the financial press, including articles on Motley Fool, and tips from our Champion Shares PRO service. Our discussion boards are another valuable resource, and you can use them to sanity-check your ideas.
Some of the most powerful tools for expanding your investment horizons are the various filtering facilities available from the likes of ADVFN, Digital Look and Sharelockholmes. These can help you construct a shortlist of shares for further research, and I'd be surprised if the companies that best meet your criteria are the ones you see on your way to work. Happy hunting!
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