Buying blue chips doesn't mean buying what you know

My friend and trader Tim Sykes is a big fan of ignoring blue chips in favor of more volatile penny stocks -- many of which he admits are outright frauds, but can still serve as vehicles for profitable speculation.

In a recent post, he mentions the huge losses shareholders have been handed at the following companies: Merrill Lynch & Co. Inc (NYSE: MER), The Bear Stearns Companies (NYSE: BSC), Citigroup Inc (NYSE: C), MF Global Ltd (NYSE: MF), E*Trade Financial Corp (NASDAQ: ETFC), Sirius Satellite Radio Inc (NASDAQ: SIRI), Bank of America (NYSE: BAC), Washington Mutual Inc (NYSE: WM), Thornburg Mortgage Inc. (NYSE: TMA), Alcatel-Lucent (NYSE: ALU), Sprint Nextel Corp. (NYSE: S) and Intel Corp. (NASDAQ: INTC).

But there's something fascinating about the names in that list: They are exclusively banks and tech companies. I have to wonder then -- how many of the investors who lost money on those stocks read and understood the risks disclosed in the SEC filings, particularly those pertaining to to loans and accounting?

My bet is that none. It seems that the people who did the in-depth research to really "buy what they know" on the financials ended up shorting. William Ackman's brilliant bets against bond insurers come to mind.

Bottom line: Looking at some ratios and then buying a stock because it has a good dividend, high ROE and low P/E does not constitute buying what you know. The people who lost money on these stocks, I would argue, had no idea how the companies they were investing in really earned their money. They weren't buying what they knew after all!