Why You Don't Need an Informational Advantage, Just an Emotional One

One of those oft-repeated investing "truisms" is that since big companies like Coke (KO) or Microsoft (MSFT) or Apple (AAPL) each have a million analysts covering them, there is no way to have an informational advantage and hence you shouldn't expect out-sized gains from investing in these stocks. The market is too efficient for that when it comes to big companies.

Sure this makes intuitive sense. It would even be true if the market were in fact efficient. I would hope that most folks have observed enough ridiculous pricing in the market over the past few years as to dispel any notion of efficiency.

Apparently, the folks at the Motley Fool were not among those observers. They wrote an article yesterday touting one of their "Global Gains" picks that is up 200% since October.

These are the types of claims you need to ignore unless the "manager" in question is listing how all of his picks have done, not just his "cherry pick". The reason I didn't ignore it is that the guy rolled out the above argument to justify their recommendation to invest in a tiny unknown Chinese company. Sure, it had a short history as a public co, was listed over-the-counter, and had no CFO, but it looked cheap . And, they even traveled to China and interviewed management, who actually "answered every question they had about the company". No word on whether the answers were favorable or even made sense. But heck it was trading at 5 times earnings and has no analyst coverage. This, they say, was the secret to them earning 2x their money.

The author argues that Apple, for example, is covered by 45 analysts and its every move is splashed all over all forms of media. No way to make money there. Unless of course you bought it at $80 during the panic 3 months ago. Then you would only be up a measly 75% in 3 months.

So either the market isn't efficient, even for Apple, or the value of the company has increased 75% in 3 months. I'm going with "not efficient". Any idiot could see Apple was pretty cheap relative to cash flow when you netted out the extra cash on the balance sheet. But if you listened to the aforementioned media and analysts, you were likely too damn scared to to invest in it. I mean look - Steve Jobs might have had Ebola for all we knew. So what if they have what could be the most significant tech platform since the invention of the...Mac. So what if they own music distribution. So what. The economy stinks and little Johnny just might not get another iPod this year.

In which case, according to the Fool, you should buy a tiny Chinese company that makes organic fertilizer, or something like it, so you can TRIPLE your money. Feel free, I'll pass. Do these guys really think they could know more about this company than they could about Apple? They could surely learn more about it than most other people know, which some would argue might engender a confirmation bias. Plus they would have to know whether they could believe and trust management, which is hard enough if they guy is sitting right in the middle of NYC much less in Xi'an.

The point of this rant: you don't have to travel to the Chinese countryside and give your money to a temporary CFO to find bargains, especially these days. As Buffett said, there are no extra points awarded for difficulty in investing (yes I know Buffett is now an "idiot" and Dennis Gartman is "short of Berkshire" (BRK.A)... whoop-de-freaking dooo ... Dennis WHO?). And being well known and well covered does not necessarily equate to an efficient stock price. It just doesn't. Maybe, just maybe, all that coverage can make the pricing LESS efficient. If you can ignore the mania and be guided by simple logic, you won't need an informational advantage. And you might just have enough money laying around to buy a new iPhone 3Gs.

Disclosure: Long AAPL, KO, MSFT, BRK.B

Comments

[Timeline St...:]

Interesting insight. With regard to Apple, I completely agree.

How can analysts, who presumably have access to extensive research and analytical resources, continue to miss the strategic and financial importance of what Apple is doing? It seems like, instead of looking 18-24 months ahead to define winners and losers in specific markets, they look at trailing 1-3 month share price movements and issue upgrades or downgrades based upon those movements.

Case in point - Apple hit $80 or just below in late 2008, and again in January 2009. At each point, rather than looking at the underlying financial condition, strategic position, and growth potential of Apple, many analysts just said 'more of the same', thus depriving anyone who took their advice of a stock at bargain basement pricing.

John Maynard Keynes said something to the effect of trees not growing to the sky, with roots not going to China either. Analysts would be wise to take that advice, and remove the emotion from their judgments.

Jun 26 12:23 PM

[El_gecko:]

LOL! I love your comment on Gartman & Buffett...I always feel the same when I see someone toss Buffett; nice to see someone actually respond in print with all appropriate seriousness. "Short of", eh?

Jun 26 12:28 PM

[Josh B Thom...:]

you did describe something, but nothing will change.

Jun 26 01:11 PM

[U338129:]

I love the Gartman comment. You talk about 100% on the money. I'll take it step further and say that if you plan on somehow making a name for yourself by saying something absolutely foolish then at least have the backbone to stand behind your words. All it took was CNBC calling Gartman out and he backed down like a Chihuahua (all bark and no bite).

Take Buffett's wealth and compare it to Gartman's and then ask who the idiot is:)

Jun 26 02:34 PM

[Don Bowey:]

This sounds like another typical Apple abuser from Seeking Alpha.

I believe that's three so far today unless I missed some.

Jun 26 03:02 PM

[TonyCinTX:]

As a statistician, let me say I don't know any mathematician or statistician that has worked on the market that thinks the market is efficient. For a while the idea was that it is long-term efficient but not short-term, but if the bubbles last more than five years and your averaging has to be over decades long periods, this is an empty assertion too. You can't do anything with it.

The latest (July 2009) Scientific American has a great, lengthy article on this topic. It has always been *economists* making the efficiency claim, based on their idiotic insistence on rational players and simpleton math. The same mentally retarded crowd that believes in the magical powers of free markets to set prices. For thirty years I have read study after study after study (all peer reviewed) disproving the foundational premises of economics, one after another, and still they persist in using them because presumably, that is all they have.

Hopefully, the alternative (behavioral economics) outlined in Scientific American will take root and take over, once these bozos are discredited by their failures. Or maybe not -- Economics is a non-science good at insulating itself from ugly facts.

Good article, Mr. Kenyon. One of the few I have read on this site.

On a different topic, I am long BRK-B and unconcerned by the decline. The question is whether it outperforms the **market** in the long term, I never had ANY expectation it would hold price like an island unto itself. All stocks are affected by the climate; even if their fundamentals are fine, they can be subject to selling pressure because some of the big fish incurred debts elsewhere in the market. When you are leveraged to 200% invested and there is a 25% market decline, you have to cover your margins somehow. This is just ONE of the reasons the market is not efficient. Read the Scientific American article.

Jun 27 09:23 AM

[Pcatlow:]

Tony, maybe running a Berkshire option strategy would be better (selling puts and buying calls).....bet on a further decline where a net-net positive entry with more upside would be of benefit.

The Gartman comments are funny, LOL funny, to me. He called out the supposed smartest investor on the planet. For those of you who place a lot of value on a guy who HAS accumulated a ton of cash, I would only say that as the Man From Omaha ages, his bets are not paying off quite as well as they did when he had a far fresher brain.

Jun 27 11:03 AM

[CLH:]

Its easy to put down a pick thats new because there is little known, while at the same time showing how bright you are by showing the past (Apple up). Im really not impressed by someone who can tell the past.

Crummy article Todd .

Jun 27 01:13 PM

[tkenyon:]

Tony - great comments - thanks! I will read the SA article today! You are correct that most of the academic tenants of market dynamics and economics are plain wrong since they do start with the belief that market participants act rationally. If the past few years (not to mention the late 90s) hasn't dispelled that notion permanently, I don't know what will. We hear that "markets are driven by fear and greed" constantly. I doubt you could many market participants who would disagree with that. Neither of those emotions are rational precursors to making economic decisions. There, I just disproved the EMT.

Jun 30 07:02 AM

[kagame:]

The analysis in Gartman's letter is lightyears ahead of cheerleader Todd's. Perhaps he should read it.

Jul 03 11:06 AM