Mainstream Thinking, Mainstream Investment Returns

In May 2013, six of Australia’s largest equity research houses tipped Newcrest Mining as a Buy. It’s Australia’s largest gold stock. Not one tipped it as a Sell.

So how did Newcrest fare over the following year?

Was it one of the best performing stocks on the market, as these experts predicted?

Nowhere near. In fact Newcrest’s share price FELL 33%!

That’s right. Newcrest, one of the most widely recommended picks by Australia’s leading research firms, lost a third of its value. If you’d invested $10,000, you’d be left with $6,700 today!

Just to get back to break even you need Newcrest to double in price. This could take years — time that your money could have been growing in a good stock for your retirement. So much for a safe tip from the big firms.

You might think it’s unfair to pull one bad stock from the pile. Everyone gets it wrong once in a while.

But what if I told you that the big research firms routinely get it wrong? It’s not just a mistake that happens now and then. It’s a pattern. And it happens again and again and again. Let me show you why…

Consider the analysts’ top ten tips from May 2013. This only includes stocks covered by at least four major Australian and international stock brokers such as Deutsche Bank, Macquarie, JP Morgan, and Credit Suisse. Reputable and trustworthy right? These were stocks tipped as ‘Buy’, ‘Outperform’, or which had some other label suggesting they were stocks you want to own.

‘Outperform’, by the way, is a completely useless form of advice. It means a stock might do better than the market. But if the market does poorly — say it loses 10% — and the stock loses ‘only’ 8%, it has ‘outperformed’. Industry insiders call this a relative return.

I call it misleading.

What you want is an ABSOLUTE return. You want to make money, not just lose less than the market.

 
But back to the analysts. If you’d bought their top ten favourite stocks, you’d have returned — drumroll please — an average of 2.3%!

You’re not going to retire on 2.3%. You’re not going to even beat inflation. Consumer prices are rising by more than 2.3%. Your cost of living is probably going up even faster, if you include energy and housing costs. My point is, 2.3% is an abysmal return for stocks that are supposed to be top tips.

What’s more, that average return is well below the 11.3% you could have got investing in a simple ASX Index fund in the year to May 31, 2014.

If the stocks the analysts liked did so poorly, the stocks they hated must have done even worse, right?

Nope. Pay close attention. You’re getting to the moral of the story now. The ten stocks hated most by the analysts at Australia’s biggest research firms beat the market by 3.2%. And remember, beating the market doesn’t tell you the whole story. In absolute terms, the ten most hated stocks would have returned you an average gain of 14.5%.

If Australia’s ‘best’ analysts loved stocks that did poorly and hated stocks that did well, you’d have learned something interesting today. You’d have learned that for some reason big-time analysts get it 180 degrees wrong. They love what they should hate, and they hate what they should love.

Let’s be fair. The results were for just one year. Did they have a bad year? Could it have been a one off?

I wish that were the case. But when you consider the year before that — May 2012 to May 2013 — the results were even more shocking.

The Buys would have lost you 10.1% of your investment. But the Sells would have gained 14.8%!

Once is unlucky. Twice is a pattern.

Why does the mainstream investment industry get it so wrong so often?

You’ll never hear this from them, but making you money is not the main job of big research firms.

In fact, the performance of their tips doesn’t really matter. What matters to the big firms is that they don’t do a lot worse than each other. They’re more concerned about relative performance with each other than your absolute investment returns.

But there’s also a deeper psychological point here…

Poor performance at big research firms is almost by design.

If they perform poorly, but that performance is the same as all the other firms, then they don’t stand out. More than anything, they don’t want to risk being embarrassed. They don’t want to be viewed as risky or reckless. So they play it safe and recommend the same ideas as everyone else.

Most investors don’t see it that way, of course. They feel secure in the belief that not all of these brokers could be wrong so often. You’re seeing the herd mentality in action. Mainstream thinking and mainstream returns.

Another important point to keep in mind is that a stock broker’s true purpose is to sellstocks.

Odds are, if the analysts are tipping a stock, then the firm is probably already buying it. And in that case, there’s a good chance that they’ve already driven the price up and are hoping to drive it up further.

Often when an analyst tips a stock as a ‘Buy’ you’ll see it jump, at least in the short term, which reinforces the tip and gets clients buying for a few more weeks and, more importantly, paying more brokerage fees! If the tip doesn’t pan out, they can always close your position — make some more brokerage on the way out and have the next hot tip ready to feed to you.

Meanwhile, the most hated stocks are unlikely to be held by these firms and may have been beaten down below what they’re truly worth.

And THAT is what presents you with a great opportunity.

Now this doesn’t mean that all beaten down stocks are ones you’d want to own, but at the same time they shouldn’t be written off just because they’re out of favour. There are a lot more potential buyers for these stocks. A once disliked stock will find it pretty easy to beat expectations once the herd jump aboard, while a favoured stock will struggle to gain new interest. 

Did you know that there are always more Buy recommendations than Sells? Even during the GFC, the number of Buys was significantly higher than the number of Sells. Why?

Read the rest of this article at Money Morning