Personal Preferences become Pronounced when Investing in Consumer Names
A less-than-objective approach can color our investment judgment
Peter Lynch describes how to “One Up on Wall Street” by relying on our personal experiences to uncover products and services that are growing in popularity at grassroot levels, then buying up shares of companies behind them before institutional investors do. It is a tried-and-tested formula that every investor can implement in the consumer space. For example, early fans of Nike (NKE 0.00) and Apple iPhones (AAPL 0.00) would have done very well if they had bought shares in either company. Lynch does qualify his methodology with multiple outlines of valuation and financial analyses; investors are taught ways to avoid overpaying or investing in companies that do not have sufficient viability.
Eat Your Own Dog Food
As part of any due diligence process in the consumer space, we should at least try out the goods or services of potential investee companies. But how do we know if we are not merely seeking confirmation bias? Or that our personal obsessions can cause us to overlook obvious investment pitfalls?
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Social media companies - including the likes of Snap (SNAP 0.00) and Pinterest (PINS 0.00) - present useful references in this eat-your-own-dog-food approach to investing.
Meta Platforms (META 0.00) owns two of the most popular social media applications in the world – Instagram and Facebook. Most of us are familiar with them, and likely have active accounts as well. Historical financial performance and user growth had been excellent until recent quarters, when a confluence of headwinds from Apple privacy changes, competition, and economic slowdown hit Meta hard on all fronts.
Should investors, who are heavy Instagram or Facebook users, take advantage of current share price weaknesses to increase their stake in Meta Platforms? Or should the stock be avoided because changes to data privacy have fundamentally altered its business model, such that historical performance is no longer a relevant indicator of its future economics?
Confirmation Biases at Play
For investors with a fondness for using Meta platforms, it will be easy to brush aside concerns surrounding the company to focus on what can go right. More attention will be paid to the enduring popularity of Instagram as well as Facebook, and how it can become a metaverse powerhouse under the visionary leadership of Mark Zuckerberg. On the other end of the spectrum, people who do not like using those social media platforms will find it easy to fixate on existential threats posed by Tiktok, Apple, and changing attitudes towards data privacy.
In other words, with strong personal experiences, we can form firm judgments very quickly, though they may not be the right ones.
While the Peter Lynch approach makes sense, misconception (or confusion) can come from the same personal experiences that investors rely on to uncover investment opportunities. For example, a passion for classic cars – like Porsche and Land Rover – may prevent one from seeing the potential of electric vehicles.
Likewise, a fondness for Netflix (NFLX 0.00) may lead one to invest in the stock, but without sufficient consideration of competition and potential shift in consumer preferences.
This is further compounded by how our own personalities come into play: whether we are eternal optimists who are easily swayed by blue-sky scenarios, or acute skeptics who are always looking for what can go wrong.
Enter Elon Musk and His Scientific Approach
Consider the below quote from Elon Musk on first principles thinking:
“Don’t just follow the trend. You may have heard me say that it’s good to think in terms of the physics approach of first principles. Which is, rather than reasoning by analogy, you boil things down to the most fundamental truths you can imagine, and you reason up from there”
In a Rolling Stone magazine interview back in 2017, Musk outlines his scientific approach to solving hard problems. While he is a controversial figure these days, few can dispute his technical mind that led to ground-breaking innovations, most visibly with Tesla and SpaceX. Below is extracted from that interview, and may serve as a useful framework to inject more objectivity (or reduce subjectivity) when investing in consumer-based names:
Ask a question
Gather as much evidence as possible about it
Develop axioms based on the evidence, and try to assign a probability of truth to each one
Draw a conclusion based on cogency in order to determine: Are these axioms correct, are they relevant, do they necessarily lead to this conclusion, and with what probability?
Attempt to disprove the conclusion. Seek refutation from others to further help break your conclusion
If nobody can invalidate your conclusion, then you’re probably right, but you’re not certainly right
I have found it as a useful guardrail against my tendency to get wrapped up in my own mental models, not just for investing but life in general. Hope you will too.
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