NEW YORK (MainStreet) — For years now, Evelyn Cashen has loved Plato's Closet, the retailer that sells "gently used" brand-name clothing to young adults and teens. When Cashen shopped there, she'd often make a mental note to buy the stock in Plato's parent company, Winmark Corp. (WINA). In fact, she made that same note for three years – during which time the stock tripled in value.
"I thought it was a great business model, I love shopping there, but I never took the plunge," says Cashen, 26, an account executive for Leverage PR in Austin, Tex. "Suffice to say, I regret that."
Cashen faced a common investor dilemma – whether and when to buy stock in the brands she loves. Financial experts and fellow investors say that developing a brand-based strategy can be a profitable investing tactic, but they also caution there are potential pitfalls to focusing too much on buying stock in the stuff you also love to buy.
Here are some things to consider before purchasing stocks of your favorite brands.
Diversify, diversify: By its very nature, buying stocks solely based on brands you love threatens to make your portfolio top-heavy in certain sectors. After all, while you may love and invest in Starbucks, Apple, Banana Republic and Ford, that doesn't provide you with exposure – and opportunity -- in oil & gas, utilities, bio-tech, manufacturing and foreign stocks, for example.
Elle Kaplan, CEO and founding partner of Lexion Capital Management blames "the common trap of familiarity bias" for portfolios that end up hyper-focused in one sector. "Instead of following the urge to simply go with what you know, remember that a healthy portfolio is a diversified portfolio," Kaplan says. "Your portfolio should include a range of global equities, fixed income and commodities."
Check the fundamentals: Simply loving what a company produces, the way they do business, or how they make you feel, does not a sound investment make. Sometimes when a company's products are in big demand, they fall behind on production -- hurting their bottom line and, potentially, their reputation. And a company highly focused on competing on price may offer great, affordable products, but suffer from slim margins and sluggish stock returns.
To get a good first take on the stock's potential, check out how the brand is viewed on Wall Street and if the stock is trading within its range -- meaning the history of where the stock has traded. Michael Needleman, a portfolio manager with Fusion Analytics in Manhattan, advises against buying a stock that's trading well above the range it has traded in the past unless there is news that the company has purchased another company, sold something, or shows signs that it is undergoing a significant positive transformation.
Dig deeper: If the basic fundamentals appear to be solid, it's time for a deeper dive, says Needleman. To make a more informed decision about whether to buy the stock, take a closer look at earnings and revenue, revenue projections, cash flow outlook, where the stock is trading on a current PE basis and the forward earnings projections.
Scott Greenbaum of Life Goals Asset Management in Harrison, NY, agrees that research is essential, noting that considering companies you admire "is a useful way to screen for investments, but the bulk of the analysis of the income stream from the sales of the widget remains to be done to see if the investment really has merit."
Are you willing to sell? Breaking up can be hard to do, particularly with an I-love-this-brand stock. Brand investing has the potential to add an emotional element that can cloud judgment.
"I find that most investors do have a very hard time breaking up with a particular brand given that they have such a strong emotional connection," says Michael Hardy, a certified financial planner with Mollot & Hardy Financial Planning Services in Amherst, NY. "If the stock is going up in value, they are scared to sell, as it may continue to increase, and they will miss out on more gain. And on the reverse side, they are afraid to sell and deduct losses. because the brand they believe in will come back and be stronger than ever."
To reduce emotion's role in the equation, Needleman suggests determining before the initial purchase how much stock you intend to buy, at what price points you plan to buy and sell it and what your overarching plan for the stock is.
"Always know going into the purchase if it is an investment or a trade and stick to your investment decisions," Needleman says. "Taking profits is not against the law, and should always be part of how you invest and trade."
As for Austin PR pro Evelyn Cashen, while she missed her opportunity on Plato's Closet, she did buy a brand she respects – Ford – based largely on the company's decision to run its business without taking federal bailout money. She enjoyed more than a 40% return on her investment.
"I would never buy a stock only because I loved the brand or a certain product," Cashen says. "However, if it's a brand I love and a product or market I know, then that could be a good investment. Some of the best investments seem to be made merely by observing the world around you."
--Written by Scott Westcott for MainStreet