10-07-2011, 07:30 AM
Jul 10, 2011
small change
That expert advice can be wrong
Going by stock tips from analysts can at best yield mixed results, so you must do your own homework
By Aaron Low
From politics to exercise and finance, turning to experts for advice when confronted with a problem is probably the first thing many of us do.
After all, it's what we have been doing since we were young, when we looked to our parents or teachers to provide answers to problems.
But this method of problem-solving, especially when it comes to investing and buying stocks, is not the best way of approaching the issue, as I found out.
Many research firms and financial institutions regularly issue their analysis of companies and give forecasts of how high they think a stock price could rise.
Of course, these predictions are often laced with many caveats, and advisers are quick to state that the forecasts are not meant to act as investment advice.
But regardless, many people do read these pieces of research and use them to guide their decisions on which stocks to buy.
I, too, had previously bought shares of companies based on such advice without really doing my own homework.
The result? Mixed at best.
Sometimes, the research firms get the direction of the share price correct, but it is very rare for the piece of research to get the price exactly correct within the timeframe.
I didn't lose money overall, but I certainly did not profit that much either.
A study by The Wall Street Journal (WSJ) confirmed my suspicions: Experts get it regularly wrong too.
In a WSJ report in January, 10 of the most-favoured stocks by analysts showed they had an impressive 24 per cent return. By contrast, the S&P 500 overall gained just 13 per cent.
But here's the kicker: The 10 least-liked stocks - the ones with the sell signs - had a whopping 32 per cent return.
The journalist concluded rather snidely: 'When your broker calls to offer you his analysts' top picks for 2011, maybe you'd be better off asking him which stocks his analyst hates. Or you could just let the phone ring.'
These observations are backed up by a bigger study of expert opinion as a whole by American psychologist Philip Tetlock.
In 2005, he published a book based on a 20-year study of hundreds of experts across a wide range of fields, from politics to psychology, economics and sociology.
He made them do a forecast on the areas they had expertise in, and meticulously tracked all 28,000 of these predictions.
The conclusion? They didn't do better than random chance.
Or, in other words, they did not do significantly better than throwing a dice.
I am not discounting the ability of these experts and am certainly not saying they are not good at their work.
But what these studies simply imply is that making a forecast on a subject such as investing in a world as complex as ours is an extremely difficult thing to do.
The interweaving lines of influence means that in a complex world, no one is sure exactly what, for example, an event like the Japanese earthquake would mean for stock markets and companies.
For instance, some analysts predicted that Apple shares would fall following the earthquake, because supply chain disruptions would affect the company's ability to deliver its popular iPad product.
It did fall from US$360 by more than 10 per cent in two weeks. But quite soon after, it rose right back again, even though the supply disruptions were still there.
And here is the last reason why people should not trust experts: They do not owe you a single cent if they get their predictions wrong. You are responsible for your own hard-earned money.
So I have learnt to try to be an expert on my own, because there's no one I'd rather trust than myself.
aaronl@sph.com.sg
small change
That expert advice can be wrong
Going by stock tips from analysts can at best yield mixed results, so you must do your own homework
By Aaron Low
From politics to exercise and finance, turning to experts for advice when confronted with a problem is probably the first thing many of us do.
After all, it's what we have been doing since we were young, when we looked to our parents or teachers to provide answers to problems.
But this method of problem-solving, especially when it comes to investing and buying stocks, is not the best way of approaching the issue, as I found out.
Many research firms and financial institutions regularly issue their analysis of companies and give forecasts of how high they think a stock price could rise.
Of course, these predictions are often laced with many caveats, and advisers are quick to state that the forecasts are not meant to act as investment advice.
But regardless, many people do read these pieces of research and use them to guide their decisions on which stocks to buy.
I, too, had previously bought shares of companies based on such advice without really doing my own homework.
The result? Mixed at best.
Sometimes, the research firms get the direction of the share price correct, but it is very rare for the piece of research to get the price exactly correct within the timeframe.
I didn't lose money overall, but I certainly did not profit that much either.
A study by The Wall Street Journal (WSJ) confirmed my suspicions: Experts get it regularly wrong too.
In a WSJ report in January, 10 of the most-favoured stocks by analysts showed they had an impressive 24 per cent return. By contrast, the S&P 500 overall gained just 13 per cent.
But here's the kicker: The 10 least-liked stocks - the ones with the sell signs - had a whopping 32 per cent return.
The journalist concluded rather snidely: 'When your broker calls to offer you his analysts' top picks for 2011, maybe you'd be better off asking him which stocks his analyst hates. Or you could just let the phone ring.'
These observations are backed up by a bigger study of expert opinion as a whole by American psychologist Philip Tetlock.
In 2005, he published a book based on a 20-year study of hundreds of experts across a wide range of fields, from politics to psychology, economics and sociology.
He made them do a forecast on the areas they had expertise in, and meticulously tracked all 28,000 of these predictions.
The conclusion? They didn't do better than random chance.
Or, in other words, they did not do significantly better than throwing a dice.
I am not discounting the ability of these experts and am certainly not saying they are not good at their work.
But what these studies simply imply is that making a forecast on a subject such as investing in a world as complex as ours is an extremely difficult thing to do.
The interweaving lines of influence means that in a complex world, no one is sure exactly what, for example, an event like the Japanese earthquake would mean for stock markets and companies.
For instance, some analysts predicted that Apple shares would fall following the earthquake, because supply chain disruptions would affect the company's ability to deliver its popular iPad product.
It did fall from US$360 by more than 10 per cent in two weeks. But quite soon after, it rose right back again, even though the supply disruptions were still there.
And here is the last reason why people should not trust experts: They do not owe you a single cent if they get their predictions wrong. You are responsible for your own hard-earned money.
So I have learnt to try to be an expert on my own, because there's no one I'd rather trust than myself.
aaronl@sph.com.sg
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/