As investors, we believe it is possible to estimate a range of intrinsic value for a company based on its financial statements and filings. This can not be done, however, if you do not understand how a company makes money. For example, if you do not know anything about telecommunications equipment, you should not invest in Lucent Technologies. Why? Unless you understand the company's products, market, competitive strengths and weaknesses, you will not be able to project future cash flows.
In his lectures and writings, the famous investor Warren Buffett often discusses the concept of a "circle of competence." This circle of competition consists of all the companies with which the investor is familiar and thoroughly understood. An investor who has spent the last ten years as an inspector at a supermarket would have an edge when analyzing the financial statements of a chain of grocery stores; he or she will be able to identify the strengths and weaknesses of the company, evaluate the climate of competitive industry, and compare the performance of a prospective investment with an excellent grocer.
The size of an investor's circle competition is not as important as clearly defined borders. If you're unfamiliar with the insurance industry, not even attempt to evaluate the performance of a property and casualty. Similarly, if you do not understand the Internet, did not bother ordering the annual report of an Internet population. Depart from the circle of competition leads to potential investors-in the realm of speculation.
The discovery of investment ideas
How to find companies that you can understand? Take a trip to your local commercial and scouts from the shops to see what is popular. Pay attention to your children wherever you take for their return to school shopping. Peter Lynch, one of the most successful money managers in history, has some of his best investment ideas from listening to his wife and children after returning from errands. In fact, Lynch bought shares in Hanes after his wife brought home the newly introduced L'eggs discovered while in line buying at the supermarket, the investment made millions.
Another way to get ideas investment is to go through your pantry, closets, laundry, garage and find the products they use regularly. Most of the labels contain information about the product's manufacturer. You may be surprised by what you find; what Tide, Pampers, Always maxi pads, Pantene Pro V, Charmin Toilette paper, Bounty paper towels, folders Coffee, Crest toothpaste, Pringles potato chips, Downy fabric softener, Oil of Olay, Bounce, Cascade, Cover Girl, Fixodent, Mr. Clean, PERT Plus, Pepto Bismol, Old Spice, Noxema, Millstone Coffee, Max Factor, Febreze, Giorgio Beverly Hills, head and shoulders, herbal essences , Gain, Ivory, Luvs, Joy, scope, Sunny Delight, Tampax, Zest, and Vidal Sasoon have in common? All of them are made by Procter and Gamble. Sara Lee is another company with well-known brand names including Hanes underwear, Hillshire Farm, Playtex, Sara Lee food, sportswear Champion, L'eggs, Jimmy Dean, ballpark Hotdogs, Kiwi Shoe Care, and Wonderbra.
Price still matters
Finding companies that are easy to understand is just the beginning. The circle of competence test should be merely a starting point to generate a list of investment opportunities on the basis of an investor individual strengths and viewpoints. A company must show an excellent economy, an attractive price and shareholder-friendly management. When discovered, this holy grail of investment insurance to produce stellar returns for the investor's pocket.
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