‘Invest in What You Know’ – Always a Good Idea?

by Carla Lake | October 9, 2013 8:30 am

penny stocks, young investors[1]One of Warren Buffett’s famous investing tips[2] is “Invest what you know.”

The idea is that if you have special knowledge of a particular industry, you’re more likely to understand the advantages or downsides of the companies within it. But when I researched a stock related to my interests, I quickly realized that there’s a lot more to consider — from fundamental analysis to figuring out what the unknown risks are.

In keeping with my very niche hobby — horseback riding — the company I found was a small one. Dover Saddlery (DOVR[3]) is a tack (riding equipment) shop selling everything from saddles to spurs in their stores, catalog and online.

I’m a regular customer at Dover’s stores and website, so I know it’s a legitimate company. Their stores have beautiful wood-paneled walls, a wide variety of competitively priced products and helpful employees who are all experienced riders[4]. It’s a great customer experience, and they’re the only big-box alternative to mom-and-pop tack shops.

However, several red flags made me shy away from DOVR stock. It’s a nano-cap[5] with low trading volume[6] and a price under $5[7] since the 2008 financial crisis. All of these are generally signals to stay away. Yet when I looked at Dover’s earnings reports, I found fundamentals that seemed positive.

Dover plans to open three new locations this fall, bringing its total number of stores to 25. Same-store sales have improved 9.4%  compared to the same quarter last year. And Dover’s revenue is up 8.6% year-over-year. All of these aspects seem to point to future growth for the business, and if you take Google Finance’s 24.79 trailing P/E value for DOVR at face value, it seems investors are willing to pay a premium for future growth in the company.

So what gives?

The “aha” moment came when I found that a deal is in the works[8] for DOVR to be taken private (that is, bought and taken off the stock exchanges) by one of its biggest shareholders, North Star Investment Management Corp. A stock that might not be around for the foreseeable future isn’t exactly a growth prospect.

One of Dover’s press releases[9] confirmed these talks were under way, but in the most noncommittal business jargon possible:

The Company stated that there can be no assurance that the Board’s exploration of strategic alternatives will result in any transaction being pursued, entered into or consummated, and there is no set timetable for the strategic review process. The Company does not intend to comment further regarding the evaluation of strategic alternatives until such time as the Board has determined the outcome of the process or otherwise has deemed that disclosure is appropriate.

It’s impossible to tell exactly why the board of directors is now considering a potential buyout, when investors can expect a decision, or whether anything will come of it at all. And since Dover “does not intend to comment further,” that’s exactly the way they want it.

There are certain aspects of a business that investors can never know. And it’s not just specific to weird, niche industries like saddleries. Say you’re considering Apple (AAPL[10]). You understand the tech space and you’ve researched everything there is to know about AAPL stock … but you’ll never know exactly why the company decided to focus on the high-end market with the iPhone 5C and 5S rather than going with a super-low-cost iPhone as so many people thought they would[11].

“Invest what you know” is a good guideline because if you stick with businesses you understand, you’ll have a special knowledge of their strengths and weaknesses (and you’ll probably enjoy keeping tabs on your stock). But it’s but not a hard-and-fast rule, since there’s no way to know the full picture of any stock, whether it’s one of the most well-known brands in the world or a small chain of retail stores.

But if “what you know” is surpassed by what you don’t, it’s probably best to steer clear.

Like what you see? Sign up for our Young Investors e-letter[12] and get practical investing advice delivered to your inbox every week!

As of this writing, Carla Lake did not hold a position in any of the aforementioned securities.

  1. [Image]: https://investorplace.com/hot-topics/young-investors-series/
  2. famous investing tips: https://investorplace.com/2013/09/warren-buffett-investing-tips/
  3. DOVR: http://studio-5.financialcontent.com/investplace/quote?Symbol=DOVR
  4. all experienced riders: http://www.doversaddlery.com/Employees/a/374/
  5. nano-cap: http://www.investopedia.com/terms/n/nanocap.asp
  6. low trading volume: https://investorplace.com/2012/04/penny-stocks-low-volume-trumps-balance-sheets/
  7. price under $5: https://investorplace.com/2013/09/penny-stocks-to-buy-marijuana-stocks/
  8. a deal is in the works: http://www.thedeal.com/content/consumer-retail/dover-saddlery-positioned-for-take-private-deal.php
  9. One of Dover’s press releases: http://investor.shareholder.com/dovr/releasedetail.cfm?ReleaseID=792474
  10. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  11. thought they would: https://investorplace.com/2013/08/tuesday-apple-rumors-cheaper-iphone-to-sell-92m-units-in-2014/
  12. Sign up for our Young Investors e-letter: https://order.investorplace.com/?sid=YIS100

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