Look, first off, I don’t know. And secondly, if you’ve been around us very long at Beacon you know that we are not stock pickers and will never be stock pickers, for reasons that we have laid out many, many times. The title of this blog is meant to be slightly tongue-in-cheek (because Tesla is not exactly “next” anymore) and click-baity (because everyone has an opinion about Tesla).
But still! Tesla–a company that as of earlier this week had roughly the same market cap as Ford and GM combined–offers a rich ground for exploration into investing questions, and the question I want to attempt to answer today is: Should you “buy what you know”?
I, like many people, believe the cars Tesla makes to be objectively good products. They are mostly aesthetically-pleasing, they are well-engineered and built with high-quality components, and they are of course powered by electricity, traveling more efficiently than their combustion-engined rivals. There is the rumored million-mile battery. The short of all this is, Tesla has very quickly become a serious contender in luxury cars, despite being a relatively new player in a capital-intensive industry with incumbents that have been around for several decades. In fact, in 2018, Tesla was the best-selling premium car in the U.S.!
So far so good, we appreciate the sometimes disturbing genius of Elon Musk’s car company. But then we move to the question at hand: Should you “buy what you know”?
The question refers to a phrase coined by the great investor Peter Lynch, in which he famously advocated for investing in companies you are familiar with on a deep, fundamental level. What about Tesla?
Let’s say you buy a Tesla (the actual car). Phenomenal. The question is now, after having done all the research, after having dealt directly with the company, and after having been around so many other Tesla aficionados and been on so many Tesla web forums, should you buy what you know and invest in the company? Or let’s say you work at Tesla, you’re one of the engineers who designed the incredible machine. You know more than even Elon Musk about how a Tesla works and is put together. Should you buy what you know? Or let’s say you work for one of the suppliers of Tesla, you make an integral component or set of components for its manufacturing process. Should you buy what you know?
After all, Tesla has roughly the same market cap as Ford and GM combined, and with a fraction of the sales, a fraction of the balance sheet, and a fraction of the experience…
Here’s the thing: “Buying what you know” is one of the greatest temptations investors face, especially those investors who know enough to be dangerous. And the reason it’s such a temptation is twofold (at least):
The first reason is, it’s one of the easiest things in the world to forget that there is often a tenuous relationship between the quality or cultural cache of a company’s product (or service) and its success as a long-term investment. Great products have driven companies out of business just as poor products have kept them in. At the end of the day, if a company can’t sell something to enough people at a high enough margin for a long enough period of time while pleasing enough shareholders and missing enough unlucky breaks and getting enough lucky ones and managing people and dealing with recessions and getting a new CEO…well, if the company you “know” can’t do all those things (and better than its competitors), then maybe you ought not “buy what you know.”
The second reason is, supposing you’re actually in possession of legitimately important and material information, it’s even easier to forget that you probably can’t profitably trade on the knowledge you possess. Why? Because the knowledge is either a) already public information (meaning the incredibly efficient market has already priced it into the stock), or b) it’s insider knowledge that could land you in jail if traded upon. More strikes against “buy what you know”!
Josh Brown posted a fascinating anecdote about Apple on his Instagram feed earlier this week, and I think it can help us wrap our minds around this question from a different angle. In it he quotes a New York Times article from 1983 about the company, comparing and contrasting it to its competitors at the time:
“Although it may sound surprising, Apple Computer has never really been a technological leader. As the famous dynamic Apple duo of Steven Jobs and Stephen Wozniak were ‘inventing’ the personal computer in a garage, a number of other personal computers, emanating from Imsai, Mits, Ohio Scientific, Polymorphic and Processor Technology, were already out in the real world.
What Apple did invent was the marketing plan that converted the microcomputer from an elegant technical toy into the small-business man’s leading-edge tool and launched computers into the sea of mass merchandise. Some of the other companies turned out computers in many ways superior to Apple’s, but if an item doesn’t sell well enough ….”
So maybe Tesla is the next big thing. Maybe they will be as ubiquitous as Honda and Toyota in five or ten years. Maybe they will put those incumbents out of business in twenty. But on the other hand, maybe they won’t. Maybe a company we don’t even know about will come along with a product not quite as good, and yet sell way more of them, just like Apple did to all those other PC manufacturers I’ve never heard of.
In closing, the best way I can think to buy what you know is to just buy the whole dang market. As of the writing of this post, the Vanguard Total Stock Market ETF (VTI) holds 3,561 stocks according to market cap. Everything you know is in there (plus way more you don’t), so long as its publicly traded. Holding something like VTI is perhaps less exciting than some alternatives, but evidence would show it’s more likely to lead to you reaching your goals in one piece than “buying what you know.”
Reaching goals in one piece–that’s why were here. Until next time!