Fad Investing

About two years ago I was speaking to a friend who was very excited about an investment opportunity. "This company is a sure thing, my kids all have these and I saw Oprah was wearing a pair of them last week so they are going to have a huge quarter." He was right and saw his money double, and then a year later fall 20% below what he had paid for it.

So what went wrong? My friend is a huge advocate of the buy what you know adage made popular by Peter Lynch. He looked at his own life and picked products that he saw his family using. He coupled this with some stingy investment criteria that the company was undervalued in relation to the upcoming sales. All good things. What he forget was that he was fad investing.

Fad investing is the process of investing in a company because of a product; not because of the company. This happens every year with companies like Potash, and Krocks. There are some simple ways to avoid fad investing:

• Look at the stable. What else does the company have, is this one of 20 products they produce?
  


• Check the weight. What percentage of revenue is going to be absorbed by one product line. If it were to dry up how would this impact the business?
  


• Looks for Sustainable Competitive Advantage. I've written about this Buffet criteria before. The company that is producing this great product, is there something that would prevent others from making this product cheaper or slightly better?
  


• Think about need. In economies like the present, having a product that doesn't make people's lives better/easier/more efficient is a dangerous dance.

Remember too that few companies rise to greatness on the backs of one great idea.

Starting a company with a great idea might be a bad idea. Few visionary companies began life with a great idea. Furthermore, regardless of the founding concept, visionary companies were less likely to have early entrepreneurial success than the comparison companies in our study.
p.7 Built to Last James C. Collins

So if you are in for the long haul then invest in a company not in a fad.

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