Beginner's guide to investing part 4: Know the product

In part four to the beginner’s guide to investing series, I focus on one tip: know the product.

Article updated: 23 October 2020 12:00pm Author: Michael Baxter

Warren Buffett once said: “Invest in what you know...and nothing more.” I think that is superb advice.

There is a theory that the markets price in the future; you can only beat the markets with luck. It is called the 'efficient market hypotheses'. If the markets project future dividends for a company and discount those dividends to create a net current value, and if the markets are the aggregation of the decisions of highly skilled professionals, then it is impossible to beat them. Or so goes the theory. 

This ties in with the idea of Wisdom of the Crowds. Francis Galton, a statistician, visited a country fair in 1906. There was a 'guess the weight of an ox' competition. And none of the guesses were accurate. But Galton noticed that if you took all the guesses and calculated an average, it was within a tiny margin of the correct answer.

From this comes the idea that the crowds always perform better than the individual in specific tasks — the wisdom of crowds. And, or so it is argued, the markets projecting future dividends and discounting, is a classic example of this. Ergo, continues the argument, you can’t make money from investing.

I have three issues with this argument. Firstly, the lesson of investing over time suggests this is not true. Stock markets have gone up significantly over time — if the above idea were accurate, this wouldn’t have happened. Secondly, I dispute that the markets are rational. I will return to that next week.

But there is a third point, and that takes me back to Warren Buffet and to one investing tip which I think overrides all the others. Product matters.

Let me give an example. About eight or nine years ago, I began to appreciate precisely how exceptional a product the iPhone was. I was a user and a fan. I said so in this column over and over again. The Apple share price has increased roughly tenfold since then.

If you think a product is brilliant, don’t immediately go out and buy shares in the company that sells it, but do take this as an invitation to look closely at the company. I think the markets are lousy at doing this. 

My background is in technology and marketing. As a result, quite early on, I realised how cost-effective Google and then Facebook had become for advertising. And I said so here enough times. The markets fail to appreciate this.

Moving away from tech, I have long believed I can second guess the future movement of the Marks and Spencer share price just by watching my wife walk around the store and observing her body language. 

What helps, of course, is specialist knowledge. To repeat from Mr Buffett, “invest in what you know.”

But I would say that if you don’t have the specialist knowledge, you can acquire it. You can acquire it by reading trade magazines or books targeted at an industry you are looking at and attending events.

It’s the three Rs again, which I described last week: research, research and research.

But product matters too. 

For more in this series, see: 

Beginners guide to investing in shares

Beginner’s guide to investing part 2: risk, volatility and why invest?

Beginner’s guide to investing part 3: five tips for investing

These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees.

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.