Sony has come out with the PlayStation 4, yet another device that will addle male teen minds and do little for the company's stock.  Photographer: Erin Lubin/Bloomberg
Sony has come out with the PlayStation 4, yet another device that will addle male teen minds and do little for the company's stock. Photographer: Erin Lubin/Bloomberg

Folksy stock-pickers like to say that you should "invest in what you know," but that's actually terrible advice. I know this because I tried to profit from this principle almost 14 years ago and instead ended up losing a bunch of money on Sony Corp. shares.

I'm reminded of that episode because Sony has just released its latest game console: the PlayStation 4. So far, the system has sold extraordinarily well, although that isn't enough to keep the bean-counters at the Financial Times' Lex column from declaring that Sony's electronics business "is worth less than nothing."

My story has to do with the release of an earlier Sony game console. The PlayStation 2 wouldn't come out in the U.S. until the end of October 2000, but it was released in Japan in March of that year. At the turn of the new millennium I got some money for my birthday and thought I should put it to work in the markets rather than, say, spend it on something I would actually enjoy -- like a PlayStation 2.

(That's one sign of a bubble: teenage boys squandering money they could use for video games to bet on stocks.)

I picked Sony because I was excited about playing the new system and because I had read some news article saying that Japanese customers were pre-ordering the system in droves, as well as some positive early reviews. I figured that this would presage strong demand in the U.S. and Europe, so I bought a few shares. I don't remember exactly when I bought the stock and exactly when I sold it, but this chart gives you a rough sense of what happened:

The reason I lost so much money was because I didn't understand how to value stocks. So unlike Warren Buffett, who profits by buying solid companies below their fair value, I ended up grossly overpaying for a storied but declining conglomerate.

Companies, no matter how cool or successful, are worth no more than the sum of their future earnings discounted by some benchmark rate of return. Many smart people armed with data are constantly trying to predict those future earnings and estimate the proper discount rate. Sony's share price already contained assumptions about the sales performance of the PlayStation 2 at the time I bought my stock, to say nothing of the rest of the conglomerate's business lines. Those assumptions may have been even more aggressive than what I would have guessed had I known enough to run the numbers myself. Everything I had been expecting, and more, was already priced into Sony's shares.

In spite of my loss, my Sony trade taught me a lesson: If you want to play with the pros, you must figure out what market prices currently imply and then determine whether you disagree with those forecasts. Most people fail to do this, which is why gimmicks such as Motif Investing will always appeal to a certain set of unsophisticated gamblers.

Can you think of any other field where so many casual hobbyists think they can consistently beat highly paid experts? I once worked alongside some of the best investors in the world, and even they found it hard to beat the markets. Me, I know my limits; I'm sticking with index funds.

(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)