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Buy what you know? Shares you don’t know can prove better

“Buy what you know.”

In one form or another, novice investors often hear advice like that. Investing legend Peter Lynch, for instance, based a number of the most successful investments in his Magellan fund on just such a strategy.

Warren Buffett, to choose another investing legend, has spoken of investments passing his ‘refrigerator test’. In other words, do potential investments manufacture and sell well-known products, beloved of consumers?

And given the money that he’s made from refrigerator stalwarts such as Heinz and Coca-Cola over the years, it’s difficult to argue that the strategy hasn’t worked, at least for Buffett.

Tailspin

But for another take on the strategy, consider budget airline Flybe (LSE: FLYB). Floated at 295p a share back in 2010, Flybe has been battered by turbulence ever since.

By early 2014, the shares had sagged to 150p. By early 2018, 50p. At that point, Flybe was still a £100 million airline. But at the time of writing, it’s worth about £5 million—and there’s an offer on the table to take the whole business private at a valuation of £2.2 million.

Put another way, that’s just 1p a share.

City institutions have taken a hit, of course. But so have small shareholders, many from the West Country, where Exeter-headquartered Flybe is a popular and well-known airline.

Maybe buying what you know wasn’t such a great idea.

Unpleasant aftertaste

The débâcle that is Patisserie Holdings (LSE: CAKE), owner of the Patisserie Valerie bakery chain, is another example.

Back last summer, I remember reading an article in the Financial Times, of all places, that extolled the virtues of this high-performing simple-to-understand business.

Er, no. As accusations swirl, there’s a suspicion that it’s not only the company’s delicious pastries that have been in Patisserie Valerie’s ovens: the books may have been cooked, as well.

A simple-to-understand business, to be sure. But a bit more complicated than some shareholders thought, it seems.

Fooled by the familiar

Getting inside investors’ minds is always difficult.

But at a rough guess, I’d say there are mistakes being made on two levels, here.

First, the lure of the familiar. You know the brand, you like the product—what can go wrong? As we’ve seen, plenty.

But the lure of the familiar isn’t the only danger, here. There’s a second bit of mental myopia going on: the disregard of the unfamiliar.

Opaque names

The unfamiliar?

Take a look at the FTSE 100, and you’ll see a lot of familiar names. Even ordinary folk who don’t take much of an interest in business can hardly to fail to recognize where they bank, who insures their car, where they shop, their electricity provider, and so on.

But what does Antofagasta do? Or Bunzl? Or Croda? Or Halma? Or Mondi? Or Smurfit Kappa?

Among popular Real Estate Investment Trusts (REITs) and investment trusts, especially those in the FTSE 250, names can be even more opaque.

What does Hammerson do? (Answer: it owns shopping centres and retail parks in 14 countries.) Scottish Mortgage? (Answer: it owns stakes in the likes of Amazon, Tesla, Facebook, and Alphabet—the company that owns Google.)  Temple Bar? (Answer: it owns stakes in juicy dividend-payers such as GlaxoSmithKline, Royal Dutch Shell, and HSBC.) Or Tritax Big Box? (Answer it owns enormous warehouses and logistics depots at strategic motorway junctions, leasing them to the likes of Amazon, Tesco, DHL, and Morrisons.)

A little knowledge can boost returns

Well done, if you knew that—but I reckon that it puts you in a minority among most ordinary investors.

And—out of interest—I own stakes in all those companies. Their names may not reveal much about what they do, but the profits they earn are indisputable.

The moral? It can pay to plough different furrows, and strike out into the unfamiliar.

Next time you see the name of an unfamiliar company, take the trouble to find out a little more about what it does.

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Malcolm owns shares in Tesco, Hammerson, Scottish Mortgage, Temple Bar, GlaxoSmithKline, Royal Dutch Shell, HSBC, Tritax Big Box, and Morrisons. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Alphabet (C shares) and GlaxoSmithKline. The Motley Fool UK has recommended HSBC Holdings, Patisserie Holdings, Tesco, and Tritax Big Box REIT. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.