Friday, March 22, 2013

Why It Is Best To Avoid Glamour Stocks

This article is going to give you a great piece of investment advice, and not in the sense that it is going to give you any buy or sell ideas over a stock. In any case any serious private investor shouldn’t be making investment decisions solely based on the words of a journalist, broker or finance adviser. It’s all well and good to take advice, but the key is to do your own research and make your own decisions.

There Are More Things in Heaven and Earth

And there are more ways to do this rather than invest in Apple (NASDAQ: AAPL). You should know this. Your broker should know this. Your advisor should know this. In short everyone should know this. Well if that is the case why does an inordinate amount of discussion take place over the stock? The answer is simple. It’s probably the best known brand in the world and everybody has an opinion on the iPhone. Herein lies the problem. The stock attracts a huge amount investor recognition, and both private and professional investors seem obsessed with trading this stock. That’s just the way it is. You can analyze the company to death but the direction of the share price is more about sentiment over the iPhone’s future market share than it is about the current fundamentals. Its stock price seems to be a kind of vote over the iPhone.

Of course if you have strong views on the subject then go ahead and invest, but if you don’t then stay away because this stock invariably attracts hot money. Whatever you do, don’t buy or sell this because you feel obliged to have an opinion on it.

Icahn vs. Ackman, Who Will Win?

The battle over Herbalife (NYSE: HLF) has fascinated commentators and investors, and for good reason. The story invokes our love of the thrill of a high stakes game between two individuals driven by a mutual dislike. Ackman holds a conference to outline the reasons behind his very aggressive short position. Icahn later buys the stock and very publicly lambasts Ackman claiming that Herbalife could be the mother of all short squeezes. The fact that all of this is being played out so publicly tells you all you need to know.

These guys are surely trying to influence other investors to join in this game. And a game it is. This isn’t so much about the underlying fundamentals as about who is going to get the most investor votes and force the other to climb down.Who really knows what will happen and how this will play out, so why get involved in this game? It’s a lot of fun to discuss and debate the ongoing developments, but this is not the kind of situation that serious investors should be involved in.

My Advice?

My idea is simple. Call your broker or investment adviser, ask about these two stocks and if he spends half an hour gushing over them with trading advice and exhortations to take a position then politely close the phone and start thinking about finding a new adviser.

Investing is hard. It requires a relentless commitment to research and a disciplined and methodological approach. Unfortunately these aspects of investing are far too easy for private investors and professionals to discard. Private investors are encumbered by a lack of time but for professional investors there is no such excuse. It’s all too easy for professionals to focus on glamour stocks or the most popularly discussed situations. They bring instant recognition and they get their investors talking and trading. Moreover investors expect their advisers and fund managers to ‘have a view’ because to not do so would be to be out of the ‘smart money’ loop. When will this nonsense stop? When will investors stop handing over money on to advisers on the back of their opinions on one or two glamour stocks?

 The Law of Small Numbers

The nonsense doesn’t stop there. Consider the law of small numbers or the understanding that a larger sample of data gives a more accurate measure of performance than a smaller set. This is the reason why the number of patients goes up with later stage clinical trials. Pharmaceutical companies generate much more accurate data with later stage trials, and approval decisions are based on them and not on early stage data with a relatively small sample. With this in mind, why do investors trust fund managers on the back of their performance over one year or with a data point of one?

Two classic examples of this tendency are the hedge fund managers Andy Zaky and John Paulson. The former achieved fame and investment funds due to his analysis of one stock. No prizes for guessing it was Apple! And no bonus for working out that Zaky went on to lose investors significant sums of money as outlined in this article. As for Paulson, he achieved fame and investment thanks to his outstanding performance during the recent financial crisis. While this deserves applause, it still does not represent a long term track record of performance; but that didn’t stop investors giving him huge sums of money. The result is that he has had a lousy couple of years, and Morgan Stanley is now reported as telling its clients to redeem their investments.

The Bottom Line

The moral of the story is to avoid highly popular story stocks or short term records with limited data to back up an investor's performance. Investing is a hard grind and it requires a lot of hard work. It is easy for the investment industry to focus on high profile stocks and applaud and promote themselves on the back of a good year or two, but serious investors should not allow themselves to get seduced into investing with them.

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