5 Reasons To Doubt My Analysis

by Daniel Sparks

writer at

the Motley Fool

With the growing influence of securities analyst recommendations and the proliferation of financial bloggers, there is good reason to question their usefulness. Although probably not a surprise to anyone, I think it’s worth some discussion: Just because I invest in a particular stock does not mean you should invest in the same one, or vice versa. There are just too many outside factors to consider: allocation, personal conviction, available capital, time horizons, investment philosophy, circle of competence, etc. But this does not discredit the stock analysis write-ups and recommendations of financial bloggers. In fact, financial bloggers can be a great resource for your portfolio . . . if you approach them skeptically.

1. Your investment framework differs from mine

It’s perfectly fine for investors to have investment frameworks that differ from each other. Though I’m a huge critic of day-trading, I find it beneficial to approach investing with an open mind so I can take in varied perspectives and use them to “innovate” my own. Due to his huge reliance on psychology in his day-trading success, I was compelled to read The Inner Voice of Trading, by Michael Martin. This pretty much sums up the underlying philosophy in the book:

To succeed in the stock market, a trader should aim to understand his inner voice and find a trading system with which his psychological make-up is compatible.

Psychology plays a huge role in investing. Michael Martin sums it up well:

“Unfortunately, most aspiring traders find out far too late that the act of trading is 20% intellectual and 80% psychological” – Michael Martin

(click to tweet this quote)

For this reason, individual investors often (and should) have slightly different approaches to investing. “It’s a complete fallacy to think that having a trading system will annul strong emotions” (Michael Martin). Therefore, individual investors should cater their investment framework to their psychological make-up while still demanding rationality.

Does Michael Martin sound interesting to you? Check out my book review of The Inner Voice of Trading.

2. Your level of conviction differs from mine

Even if you manage to buy a stock at the same price as your favorite guru, your level of conviction regarding the pick probably differs immensely. This will, no doubt, affect your sell decision down the road and could end up costing you some serious money.

3. Your circle of competence differs from mine

I have trouble understanding many companies. In fact, sometimes I feel stupid compared to other financial bloggers and securities analysts out there that so easily hold opinions regarding such a wide range of stocks. My knowledge is very, very limited and I am completely clueless regarding the sustainability of many different business models and industries. Stay within your circle of competence. If you don’t understand where cash is coming from, how management uses it to create value, and how sustainable this stream of cash flow is . . . don’t invest in it–even if your favorite guru thinks it’s the hottest thing since Google.

4. Your time horizons differ from mine

I could probably say that most value investors are long-term, buy-and-hold investors. But this does not mean we are all investing with the same time horizons in mind. An investor with only $30,000 to invest probably has a drastically different time horizon than someone with $5 million of discretionary cash, whether they realize it or not. What exactly is long-term anyway? 5 years? 10 years? 5 years is quite a bit different than 10 years. And even if we say we have a particular time horizon in mind, is that really our time horizon? Take a look at your portfolio turnover. Does it really look like your investment time horizon is greater than 5 years?

5. I make mistakes.

I make mistakes. In fact, I make huge mistakes. It’s part of investing in the stock market. Even if I’m making money, good outcomes do not mean that the underlying process to achieve these returns was a good one. How much risk did I take to achieve above average results? Was I lucky? Or, on the other side of the coin: When a guru does not have successful outcomes, it doesn’t mean he is a bad investor. Perhaps his process was nearly flawless and he has simply witnessed a bad string of luck. No matter how much we wish our success and failure was all dependent on skill, it’s just not the case. Luck plays a huge role in investing.

  • steve silverman

    here is an interesting way to think about what consttutes ‘value investing’. suppose you bought cisco (csco) when it was appreciating in 1998-1999 claining that it was a good value (based probably on its future growth prospects) suppose it had a market cap when you bought it of $200bn, it then appreciated to have a market cap of $400bn and you sold it claiming that it was now fully valued (at least to you- being a value investor). the stock continued to appreciate and became you a short while the biggest market cap in the world (at something over $500bn and maybe it hit $600bn). but, so what this move from $400bn to $600bn was not the place a value investor is to reside. but now the stodk begins to decliine in teh endo of the first quater of 2000. It goes right through the $400bn where you sold it; tgoes to $200bn (where you bought it claiming it was a value purchase), goes to $100bn and bottoms at about $50bn I think.
    Had you bought it at $100bn, on its way down, (half of what you bought it for in the late 1990s) you would have sustainded a 50% pretty quickly, and now be somewhere around even.
    so the question is: were you a value investor; were you lucky and believed a growth, momentum stock was a good value: did ciricumstances change sufficiently that a stock you bought for $200bn and held till $400bn was not attractively valued a coiple of years later at $100bn?
    but now supppose that the stock was amazon (amzn). it probably declined more from its bubble (99-00) high than cisco did but holding it- till now- would have been an excellint investment. maybe it was a value stock?
    now what?

  • this pretty much ties in with a comment I made a couple of weeks ago about how one value investing firm reviews the performance of its analysts.

    Rather than just going by performance where there is definitely luck involved, the position is reviewed 4-5 years later to see whether it really was value.

    If the analyst recommended and bought CSCO at e.g. $20 and then sold at $40, only to have the stock go back to $20 one year later, that was not considered a good performance even with the locked in gain of 100%.

    The murky part is that value investing involves taking advantage of market inefficiencies and these inefficiencies can exist even with horrible short term catalyst companies.

  • steve silverman

    (sorry if i made a number of typing mistakes in the previous email, but hopefully you got the gist)
    look at the second part of the email. had you bought amazon you would have sustained a much bigger loss from initial purchase till the trough but then had you continuted to hold it; you would have had an excellent return. supose you bought it at 50 in 1999 held it to 100 then watched it fal to below 10 in 2001 and now hold it today at 253? was it a good value purchase at 50 in 1999?

  • yes but it’s actually the same thing because based on what the initial research had said, if AMZN was held during the down period because the conviction in the research was that AMZN was going to be a killer, then that is a good result. If the research had said it was going to be difficult, but the person had held, then that is just luck.

    The end result says one thing, but whether the initial research and process matches is what’s important.

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