Why Stock Picking Is Nearly Completely Useless
Old Wall Street and old financial planning was defined by the following:
- Buy and hold strategy
- Diversification
- Stock picking
- Discouragement of alternative assets like gold
- Discouragement of any attempt at market timing
This led to an explosion of the following:
- Financial advisers – there are tons of financial advisers that really all tell you the same thing (see the list above).
- Newsletters which offer “hot stock tips”
- Wall Street profits – The above list was very conducive for maximizing wall street profits because it meant you gave them all of your money at all times
This system worked for a while. In fact, it worked well for a few decades. It worked well as long as the macro-economy was essentially a rising tide, making all boats rise in tandem. The economy was a tailwind pushing all traditional asset classes higher which meant things like buy and hold worked well.
Now where did stock picking fit in? When times are good, stock picking means you’re essentially just picking some stocks that beat other stocks but still all of them are doing ok.
Stock picking was all the rage because everyone was convinced that stocks were where you should be because the performance was so great. Stock picking gave individual investors the idea that they could generate even larger returns therefore they ate it up. Hot stock tips spread via newsletters and word of mouth like wild fire. The reality is that these tips could work if someone read the fundamentals right. Unfortunately all of this ended in 2008.
When the government intervened in the markets in the name of “stability” and to prevent “catastrophe” as we were told over and over by politicians of both parties, no longer did business fundamentals become the bigger predictor of a stock’s future performance. Traditional stock picking died.
Now, instead of diving in and finding an undervalued company, it is much more valuable to be able to dive in and predict the following:
- When will the government intervene again? Specifically, what is the Fed’s policy actions going to be in the near future?
- What global macro events will hit the markets? Today, a good example of this is the European debt crisis)
The markets have record high correlation between individual stocks and the overall market – this means more than ever, stocks are all trading together in unison based on the overall direction of the market.
Focusing your attention on the macro events and the government policies which are driving the markets much more than business fundamentals is much more valuable versus traditional stock picking. The market is really hardly an open market anymore.
What the Wall Street folks who are pro-Fed and pro-easy money might not realize is that this is eroding the confidence of the individual investors in the market. More and more investors are saying screw this and are pulling money out of the markets. This will continue to hurt the old Wall Street business models that we discussed in the beginning of this article.
The bottom line is that I hardly spend any time picking stocks. I have a few companies I like and monitor, but the majority of my focus is on the global macro environment. I’ve been telling friends now for over a year to watch Europe and wait. I tell them to wait until Europe implodes (its coming) and then to put money into some good multinational stocks which will get hammered upon Europe’s implosion. Put money in those companies then ride it back up. Stocks like Philip Morris (PM) fit that bill well. There.. I just picked a stock, but its less about PM and more about the macro environment. You could replace PM with another multinational and the performance would be similar.
The other thing we haven’t talked about yet is timing.
By focusing on macro events you can time them. When the markets rally because of another central bank printing more money, perhaps this is cause to pause and consider how long-lasting such a rally might be. Wait for stocks to come down before allocating more cash.
Lastly, often times the stock picking I do is on the short side. Most stocks I pick are the overvalued ones that people have gone nuts over. For example, Groupon (GRPN). The business model is a joke and I shorted it at $30 the day it debuted on the market. I just covered yesterday for under $17 a share. That’s a 40% plus gain in a couple weeks. I’m not a day trader and I don’t recommend day trading, but I do some trading when I see extreme case.
I am implementing this strategy at my example mutual fund that you can monitor by clicking here.
I would like to comment about the post why stock picking is nearly completely worthless. I would disagree. Their are stocks like petsmart that traded at 2 dollars a share 11 years ago now the stocks almost fifty. Also pricesmart traded at about 7 dollars a share about seven or eight years ago now its sixty dollars. Their are many other examples. Apple computer traded ar only 5 dollars a share in 1998 now its almost 400. These stocks are being held quite a long time generally speaking I would say four to ten years would be about right as far as buy and hold go. I have a website where I have been following stocks under five dollars. I generally hold my stocks anywhere form 2 to 6 years. It is not an accident that someone bought and held these stocks. If a very undervalued stock is carefully chosen and researched than their is no reason why it cannot increase
exponentially in value. This applies to stocks trading below five dollars and to stocks trading above ten dollars. I will give a perfect example to show what I mean.
I bought a stock called seaboard corporation About 10 years age and paid 190 dollars a share. I sold my shares about 5 years later for 2500 hundred dollars. The company was profitable when I bought it and profitable when I sold my shares. Bear in mind I would not say something that I cannot back up believe me. I will give an example of a company of really decent quality that I consider really undervalued. The company is Bunge Limited symbol {BG} engages in the agriculture and food businesses worldwide. The stock currently trades around 60 dollars a share. I think the stock could easily get to 450 dollars a share over the next five years. Yes you heard it right four hundred and fifty dollars a share. Assuming their are not stock splits. And what do I base this on If the companies profit margain expands from around 1.75% to 4% over the next five years and if the sales of the company expand from 55 billion to 85 billion thats growth of about 7 or 8 percent a year and if the companies stock than trades at a price earnings ratio of about 20. That would put the price of the stock at 450 dollars a share. It could even be more than 450 dollars a share if you reinvest your dividends the company pays a dividend’ also if the company does a share buyback this could increase the value of the stock even more. Keep in mind that their are stocks that are popular that trade at much higher price earnings ratios than 20 times earnings one example is whole foods market it currently trades at 35 times earnings. Also keep in mind that bunge is a company of really decent quality not at all a high risk stock. It has the potential to leave a company like proter and gamble in the dust. I understand your skepticsm if you are reading this but go to any stock broker or financial planner’ CPA that knows how to value stocks and they will confirm everything that Im saying here.
Kevin I agree with most of your arguments, but strongly disagree with your conclusion. Buy and hold only works in bull markets and correlations between asset are definitely becoming more positive. I also agree that macro economic factors and the federal reserve play an increasing role in market volatility. However all these factors make it more important than ever to pick individual stocks! Finding stocks with quality balance sheets, rising cash flow, and strategic advantages will outperfrom other strategies in this kind of volatility. Add a tactical asset allocation strategy that takes over all valuations into consideration and you have a proven winner throughout market cyles. I'm doing it; it works! http://arborinvestmentplanner.com/tactical-asset-…
Kevin I agree with most of your arguments, but strongly disagree with your conclusion. Buy and hold only works in bull markets and correlations between asset are definitely becoming more positive. I also agree that macro economic factors and the federal reserve play an increasing role in market volatility.
By focusing on macro events you can time them. When the markets rally because of another central bank printing more money, perhaps this is cause to pause and consider how long-lasting such a rally might be. Wait for stocks to come down before allocating more cash.
There are many popular stock finding strategies that are good and effective. There are certain set of criteria that stock-picking is based upon. But the bottom line will always be is that there is no actual one way of picking good stocks. But these stock picking strategies is good to be thought as an application of theories or best guesses of how to invest. And eventually these strategies will turn out to be the best for your success. You can find more tips relating this issue here: https://personalmoneynetwork.com
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Burton Malkiel, a Princeton Economist wrote the wonderful book A Random Walk Down Wall Street and I think it is a must read for any investor. It is relevant to this post because his thesis is that a monkey throwing darts blindfolded could pick stocks better than any specialist, analyst or broker. Although I do not agree with that he does bring to light some very compelling and interesting points. He also makes a strong case for ETFs and indexs. The first portion of the book is a fascinating read on the history of bubbles from Tulips in Holland to .com's of today. This alone is worth checking it out. The next little bit tries to attack analysis of securities and does an interesting job of it. Again I do not agree with his methods and theories towards investing but if you want to learn how to think as a better investor through the eyes of a conservative economist who knows his stuff this is a great book to buy or check out at the library.
You completed a number of good points there. I did a search on the matter and found the majority of persons will agree with your blog.
From what I have heard, to professionals, it's hilariously easy to pick real locks. Just like in the games. Strange that, I would have thought it was games exaggerating.
Hi! This post couldn’t be written any better! Reading this post reminds me of my previous room mate! He always kept talking about this. I will forward this write-up to him. Fairly certain he will have a good read. Thanks for sharing!
I agree with your timing the market strategy using Macro economic factors. Here in India, the opportunity in the Indian markets was huge after the 2008 crisis. The American crisis caused lot of good Indian stocks to crash. Their business was sound but the stocks crashed to 1/4 of their value. I managed to invest at the bottom and made spectacular gains (though on a smaller capital as I had made losses in derivatives in 2008).
However, I feel picking good stocks with solid fundamentals still works. A combination of both strategies is better. For example, I have invested in some solid stocks, but have also kept substantial cash to invest in case of a crash (caused by European crisis).
The articles on this blog are amazing! Keep writing.
I too agree that picking fundamentally solid stock works, but we also need to consider macro factors before investing in Penny stocks especially for the short term.
Passive investing can be a bit boring. The best way is to create a core satellite portfolio.
The core made of some index mutual funds or ETFs and few stock picks.
Now I understand why and you were able to explain it to us thoroughly. Good thing you have made this blog simple and informative at the same time. Fab Defense
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In this tutorial, we examine some of the most popular strategies for finding good stocks. In other words, we'll explore the art of stock picking selecting stocks based on a certain set of criteria, with the aim of achieving a rate of return that is greater than the market's overall average. Thanks.
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Academic studies indicate that the health of a stock's sector is as important as the performance of the individual stock itself. In other words even the best stock located in a weak sector will often perform poorly because that sector is out of favor. Each industry has differences in terms of its customer base, market share among firms, industry growth, competition, regulation and business cycles. Thanks.
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Before exploring the vast world of stock picking methodologies, we should address a few misconceptions. Many investors new to the stock-picking scene believe that there is some infallible strategy that, once followed, will guarantee success. Thanks.
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In the United States and several other jurisdictions, trading conducted by corporate officers, key employees, directors, or significant shareholders (in the U.S., defined as beneficial owners of ten percent or more of the firm's equity securities) must be reported to the regulator or publicly disclosed, usually within a few business days of the trade.
Lock picking is the art of unlocking a lock by analyzing and manipulating the components of the lock device, without the original key. Although lock picking can be associated with criminal intent, it is an essential skill for a locksmith. Thanks.
Most large companies compensate executives through a combination of cash, restricted stock and options. It is a positive sign when members of management are also shareholders. When management makes large purchases of their own stock with private funds, it may indicate that management insiders feel the company is undervalued, or that a favorable company event will occur soon. Thanks.
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I've always think about getting into stocks stuff but kind of afraid all th time when I really want to start it, perhaps just reading about stock isn't really enough and we have to do much more in order to be prepared for a start.
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