Peter Lynch, one of the most successful money managers of all time, found some of his best ideas when he was out with his family, traveling, or talking with friends and associates.
As one famous story goes, one day his wife excitedly told him how much she liked L'eggs pantyhose, a new product she'd just tried out.
After looking into the company's prospects and liking what he saw, Lynch bought the Hanes Company, maker of L'eggs, and his fund investors realized a 30-fold appreciation in Hanes' stock.
For someone starting out, investing can be intimidating. With over 5,000 stocks listed on the major U.S. exchanges, it's hard to know where to start.
Even the most intelligent people can get weak in the knees when it comes time to pull the trigger on a stock purchase.
But what they don't know is that they could already have an advantage that would put them ahead of thousands of other investors.
You don't necessarily have to spend time looking through page after page of annual reports. Instead, you can start by focusing your effort on an industry and/or companies you already know.
Finding Your Circle of Competence
Warren Buffett famously touts the idea of a "circle of competence."
How do you find your circle of competence? By using what you know about a business to your advantage and only investing in companies that you fully understand. If you don't understand the banking industry, then don't try to pick banking stocks. Banking experts will always have an advantage over you.
For example, maybe you spent several years at a retailer and you know a lot about merchandising. This special knowledge gives you an advantage. Since you understand consumer goods, this could be a good sector on which to focus your investing energy. You probably already know which companies are considered the best of the best, so you have a place to start your research.
Or maybe you are a geologist who understands what it takes to drill for oil. This insight gives you an advantage when evaluating drilling and exploration companies. It makes sense to use this insider knowledge when investing. It's perfectly legal, and it gives you a step up from the investing masses.
Dig A Little Deeper
If you've found the industries or companies you're most comfortable with, you may want to focus next on its suppliers and customers. They often realize an even greater effect than the original opportunity you have uncovered.
For example, SanDisk Corp (Nasdaq: SNDK), which manufactures storage cards for consumer electronic products, including the Apple iPhone, has jumped by +145% in one year. Apple (Nasdaq: AAPL) stock has increased by +57% over the same time period.
The Investing Answer: Your circle of competence gives you a great starting point to identify potential investments. Use your special knowledge and what you see every day to find investment opportunities.
When you find a company that you understand, that has growth potential, and that trades at the right price, you'll discover that using your circle of competence can make investing simpler than you originally thought.
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Cached on May 22, 2012, 10:42 am