Turn on the TV or your computer and you’ll find a myriad of stock recommendations from a myriad of commentators any day of the week. But in a recent MarketWatch column, Chuck Jaffe says to be careful what you do with those tips.
Jaffe notes that some firms — including Validea in an earlier incarnation — have tracked the tips of stock pundits to give investors an idea of the pundit’s track record. But what about when two commentators with good records disagree? He examines one recent situation in which two guests who appeared on his radio show — Bill Smead and Josh Peters, both of whom are value investors with good track records — had starkly different takes on the same stock within a 24-hour period. “It raises a real question on whether any tips have value at all, and the answer lies in how you use them and, of course, your results,” Jaffe writes. “People who have followed, say, Peters’ newsletter or Smead’s fund have some reason to think they are getting good advice. That doesn’t mean that stock tips — even from respected investment pros — are worth acting on based on their own merits.”
Victor Ricciardi, a professor at Goucher College and co-editor of “Investor Behavior: The Psychology of Financial Planning and Investing,” told Jaffe that investors who listen to stock recommendations should be aware of anchoring and familiarity bias, two behavioral biases that could trip them up. “Anchoring is when an investor has had a previous transaction turn out well, and so they assume similar transactions will have the same positive result,” writes Jaffe. “Familiarity bias is simply seeing something in a positive light because we recognize it. Someone who is accustomed to seeing the Morningstar name out there, but who has not heard of Smead’s fund might, therefore, hear the two stock calls and decide that Peters is right, simply because they view his firm as being distinguished.”
Ricciardi says investors should use stock recommendations as jumping off points, not be-alls and end-alls. “Halfway educated investors have some philosophy that they are comfortable with, but they need to recognize what that philosophy really is,” he said. “Here you have two value managers coming to opposite conclusions, so before you act you would want to dig in to find out what kind of value metric is being used.…If you get to the point where you say ‘I agree with that investment philosophy,’ only then does it really become a stock tip you might really be able to use.”
Validea’s Motley Fool-inspired portfolio is up 15.5% annualized since its mid-2003 inception vs. 6.2% for the S&P 500. Check out its holdings here.