People purchase goods and services from companies they like and continue to make repeat purchases from the same companies. This makes sense as we are, of course, creatures of habit. Our brand loyalty is on display every time we step into a grocery store, shopping center, or log onto an online retailer. We tend to purchase the same brand of paper towel or saltine crackers if for no other reason than it’s what we have always done. When purchasing everyday items, there is nothing wrong with frequenting the same merchants and haberdasheries. We gain confidence in their service and get to know the quality and construction of their products.
The problem lies with people using that same logic when purchasing stock in companies. I love Under Armour’s golf clothing, so why wouldn’t I purchase their stock? I ship all of my packages with UPS and always receive great customer service, so clearly purchasing their stock would be a great investment for my retirement account. As crazy as these two statements seem, it is the determining factor in far too many misinformed investment decisions. Determining the correct stock to purchase for your investment account should be based on the fundamentals of the company, an in-depth review of their balance sheet and income statement, an intimate knowledge of their growth potential and competitors as well as many other factors. The end product that is produced or service provided gives us absolutely no information on the current financial state of the company or their P/E ratio.
It is also a mistake to purchase companies due to geography. It is all too common for investors to feel like they know a company because it is headquartered in their hometown, know someone who works there, or is potentially their employer. We call this “familiarity bias”. We can convince ourselves that we have more knowledge about the company or their growth potential simply because we drive by their office every day and see a lot of cars in their parking lot.
Investing in individual stocks involves risk, and, in some cases, large amounts of risk. If you are planning to use individual stocks as the main facet of your investment strategy, be very careful to center your decisions around sound research and not flawed biases. Or, better yet in our opinion, use diversified investments with the assistance of trained professionals. For a more in-depth conversation about this topic, check out our recent podcast, “My Stock is Better Than Your Stock”.
Walkner Condon Financial Advisors