This is a response to this question:

I’ve been interested in stocks for the past few years and I’m finally looking to invest in some stocks. One thing that alot of investors recommend is to invest in companies you actually like. I was just wondering if this is a bad idea? I’ve also read about the importance of diversification - pick 5 stocks, all from different sectors, and gather information about said companies.

The companies I’m looking at are Costco and Chipotle. Both have expanded to my area within the past year and I really enjoy the service and environment. I’m a huge Apple fan and I’d love to get some Apple stock but I don’t think it’s within my budget. I feel like there stock can only rise if they meet their sales for the year with the iPhone. Nissan’s stocks look within my price range at roughly $18 a share. I feel like this may be a good pick with their shift to electric cars in 2010.

There’s some truth in the advantages to investing in companies you know. I think Apple is actually a good example. When I invested in it at the beginning of last year, everyone told me it was overvalued, “everyone loves Apple!”, etc. But I saw the huge growth in their PC market, and knew the iPhone would explode no matter what. And what happened? The stock doubled last year.

But the exact same thinking can kill you. I owned Jones Soda (JSDA) mostly for technical reasons (who wouldn’t want to own another HANS), but I also loved their soda, and thought there was a hole in the market they could take advantage of. The stock hit a high of $28 and now stands at $2.90 (though luckily I sold at $24).

So in the end, you have to have other solid reasons for investing in a stock besides the fact that you like it.

Regarding Chipotle: It was a great stock in the last bull market, but one common tidbit thrown around is that the leaders of the last bull market rarely have the same run-up in the next one. It’s in a clear downtrend since peaking at the beginning of the year.

Lastly, the price of the stock should have absolutely nothing whatsoever to do with your budget. What’s the difference between 10 shares of a $10 stock and one share of a $100 stock? Nothing! A stock is only “expensive” in terms of its price to earnings ratio. This is a common misconception I hear all the time.