Some investors wonder if it makes sense for them to invest in a company because they like the products or services it offers. This question often stems from their familiarity with the famous investment principle of legendary fund manager Peter Lynch, which is, “Invest in what you know.”
The answer? It depends. Although it can be fun and interesting to track the ups and downs of a company that makes or provides something you love, it’s not necessarily wise to put your money on the line. Choosing where to invest can be complicated and when you’re considering investing in a specific stock, there are several factors to consider.
First, it’s a good idea to know whether the company has solid financials, good leadership and enough new products or services on the horizon to remain competitive. Be prepared to invest some time getting answers to these questions because it may involve looking at analyst reports and company quarterly and annual earnings releases.
It may be helpful to track the stock you’re considering for a period of time to see how wildly it may swing or if it’s fairly steady. While it may match the ups and downs of the S&P 500, dig into any other factors that might cause that specific company’s stock to rise or fall. Perhaps one of the supplies used to make their most popular product can be in short supply based on agricultural patterns or transportation barriers. Be cautious if these types of hiccups appear to happen frequently and impact the company’s stock negatively.
If the outcome of your research is favorable, it still doesn’t mean the stock is necessarily a good buy. You should also know where the company’s stock falls relative to future earnings.
In addition, you should assess whether or not that stock is a good fit for your overall portfolio. For example, determine if this particular stock will contribute to the diversification of your portfolio, which may help you better weather the market’s ups and downs. Diversification involves having the right blend of stocks, bonds, mutual funds, and CDs to help provide for more consistent performance under a wide range of economic conditions.
As an alternative, you can look at whether the company’s stock is part of a well-diversified mutual fund, which will give you some ownership in the company while helping to reduce your risk exposure. Again, you want to make sure that the investment you select is in line with your goals, risk tolerance and time horizon.
Because of the amount of time it can take to weed though all this information and the level of industry knowledge required to understand it, consider working with a financial professional to discuss your interests before your invest. He or she can help you identify the merits of such an investment and how it fits into your overall financial strategy.
— Rick Gross is a Financial Advisor and Private Wealth Advisor with Ameriprise Financial Services Inc. in South Lake Tahoe. To contact him, visit www.rickgrossadvisor.com or 530-542-6266.