Be Careful Uncle

by Steve Visscher, Mawer Investment Management

My uncle is a great guy. He had a successful career and is now enjoying his retirement. At a recent family function he shared his investment strategy with me. Before I could respond, we were interrupted by a rendition of happy birthday and then pulled aside to mingle with other relatives. We never concluded our conversation. But since his strategy is common among do-it-yourself investors, I’ve decided to post my comments publicly. Sorry uncle. Your strategy might have more flaws than you think.

So what is my uncle’s strategy? It’s very simple - only invest in companies that you know. No more getting burned with a bad stock tip. No more investing in complicated companies that are hard to understand. No more overpriced mutual funds. Just invest in companies you know well.

This had me concerned. I fully agreed with the notion of understanding the companies that you invest in, but reducing investing to such a simple rule ignores other important factors. Can I acquire this business at an attractive valuation? How effective is the management team? How strong is the balance sheet? Even if his philosophy did address these matters, I had even greater concerns about the practicality of his approach. How could my uncle actually execute this strategy, amidst his various retirement pursuits?

So I asked what type of companies he owned now. He started by naming the who’s who of Canada’s energy sector – not surprising given my uncle’s long career in this industry. I would imagine that if his background was in technology that he would have named several technology companies. If he had worked in engineering or construction, firms in those sectors would have made the grade. He then continued with examples like CIBC, Telus, Tim Hortons, McDonalds, and Apple. Did my uncle perform extensive research to “know” these companies, or is it more likely that he was a long-time, satisfied customer of these businesses? Given his busy schedule with grandkids and cruises, my hunch was that his time researching these companies was minimal.

My uncle isn’t alone. I’ve seen other investors who have followed the philosophy of “investing in what you know” and they inevitably build similar portfolios – typically concentrated in their industry of employment, along with some of the more recognizable companies that they regularly use or interact with.

But is that knowledge or familiarity enough to invest in these businesses? At Mawer, we research a company extensively before we invest in it. We try to meet with the CEO or management team to gain more understanding of their vision and philosophy for running the business. We fly all over the world visiting companies – not just in the boardroom, but often the factory floor. We gain insight from speaking with customers, suppliers, and competitors. It would be impossible for my uncle, or any single individual, to gain this level of understanding on hundreds of businesses of all shapes and sizes located all over the world. That’s the advantage of having a larger team doing this work day after day.

I know my uncle took comfort from owning a portfolio of companies that he “knows” well. But I believe this approach is flawed. It not only lacks discipline around valuation and potential balance sheet risks, but it’s simply not practical for any single individual to execute alone. That limits the number of companies one can truly “know” and as we’ve often witnessed, it results in portfolios too heavily concentrated in companies simply due to familiarity – whether it’s the industry one works in, or the companies one interacts with. Hiring a larger team broadens the universe of opportunities and unlocks many attractive investments that one otherwise might never hear of. Be careful uncle. You don’t need to do this alone.

Steven Visscher

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