How to interpret stock picks in the media

Investors face an abundance of choice when deciding which shares, ETFs and funds to include in a portfolio. Choice is a good thing but it can be overwhelming. Many investors turn to the experts for ideas. Responding to this the financial media follows a familiar formula:

Find a fund manager
Get a couple high level quotes on opportunities that he or she currently likes
Add some fluff about how brilliant the fund manager is and some interesting personal hobbies that usually involve a $16,000 titanium bike or an extensive collection of first growth Bordeaux

No context is provided to these stock picks. We don’t know if they are a significant holding or an irrelevant percentage of the fund. Since this is a one time interview we have no idea when the position is sold. We don’t even know the real hypothesis of the fund manager because their view is generally expressed in a short quote. It is up to each of us to decide if this stock aligns to our investment strategy and do further research to validate the idea.

This week's podcast goes through how to interpret these stock picks and runs through two examples to help investors understand whether these opportunities are right for them.

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You can find the full transcript below:

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Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Mark Lamonica: So today, Shani, we are going to talk about a place that many investors turn to for stock market tips and that is the picks of professional investors that are covered in the media.

Jayamanne: And we've all seen these articles. The author of an article will find a fund manager, get a couple of high-level quotes on what he or she is currently finding interesting and then just some fluff about how brilliant they are, how hard they work and some interesting fund manager appropriate hobbies.

Lamonica: And they're not that interesting because they're always the same. Like if I had to pick these hobbies from the fund managers, they are collecting expensive wine.

Jayamanne: You like doing that?

Lamonica: I don't know about collecting, but...

Jayamanne: You like drinking it, I guess.

Lamonica: I do. I do. And then riding expensive bikes. Right? Those are the two top choices.

Jayamanne: Okay. So what would your hobby be if someone interviewed you?

Lamonica: I don't know. I mean, most of the stuff that I do probably wouldn't be considered appropriate for an article if they ever featured me in a paper. Maybe squash.

Jayamanne: Well, if you'd like to know what his inappropriate hobbies are, you can email him. Email's in the episode notes.

Lamonica: Yeah, here we go. But I think squash.

Jayamanne: Okay. You've been recently playing squash quite a lot. You've been competing.

Lamonica: Competing.

Jayamanne: Haven't won one yet?

Lamonica: Competing is pushing it. You know the answer to that question. I have not. I won a game. I haven't won a match.

Jayamanne: Okay.

Lamonica: But to be fair, the coach that was training me, is 83 years old, had vertigo and just basically couldn't move around the court. So I think I've become lazy because if I hit the ball anywhere.

Jayamanne: He can't get it.

Lamonica: He can't get it.

Jayamanne: Okay.

Lamonica: So I'm working on it. I'm working on it. What about you, Shani? What would your hobby be in your feature article in the AFR?

Jayamanne: You know what? You asked me about this and I've had to think about it and I think my hobby is lunch. I like to make lunch. I like to eat lunch. I like to book lunches.

Lamonica: Wow. That would be the most boring article ever. Fund manager Shani enjoys lunch.

Jayamanne: Yes.

Lamonica: That's like what...

Jayamanne: Isn't that what the AFR does anyway now? Like go and have lunch with a fund manager?

Lamonica: Yes. They do all sorts of stuff, but nobody's taking me to lunch. But anyway, we're going to talk about how you can use these articles as an input into your investment process. But before we do that, I think it's important to say that we both feel strongly that individual investors should not invest like portfolio managers.

Jayamanne: And that's not a criticism of portfolio managers. It's just an acknowledgement that the way professionals do things are shaped by the structures and rules in place at companies and the pressures of being successful at a job. And I think I've mentioned this before. I feel like this is a good hobby to mention. I really like F1.

Lamonica: So does everyone else now.

Jayamanne: I know, but that was after Drive to Survive. I was pre-Drive to Survive.

Lamonica: Yes, which you talk about all the time.

Jayamanne: But F1 drivers are obviously incredible drivers and I can acknowledge their expertise while saying that it would be pretty foolish to drive like them when I'm driving to wherever I drive to. Where do I drive to, Mark?

Lamonica: Well, Bunnings now because you're redoing your kitchen and bathroom.

Jayamanne: Yes. I only have one burner left on my stove, which is probably why I like booking lunches and planning lunches.

Lamonica: Yeah. And you have no lights in your bathroom.

Jayamanne: No.

Lamonica: So it's a...

Jayamanne: Soon. A dream, you know?

Lamonica: Yeah. Light. Yes. Okay. So let's get back to fund managers and not Shani's home repairs. Let's go through some examples about what professionals do that we don't think you should. So one thing professionals are much more short term focused than we think any listener to this podcast should be in their own portfolios. Portfolio managers equate risk with volatility. Well, for long-term individual investors, the risk is not achieving the goal you have for your portfolio, which makes volatility a rather useless measure of risk. Portfolio managers don't care about taxes because the end investor has to pay them. You are, of course, the end investor and what matters is not the absolute level of returns, but the returns you get above inflation and after taxes and fees. Professional investors generally have to invest in a narrow set of investments and you can invest in anything you want. Professional investors are constantly rotating their portfolios based on the prevailing economic conditions and geopolitical environment. We don't think that you should do this because of taxes and transaction fees and mostly because of how hard it is to do that correctly.

Jayamanne: I think a good way to sum this up is that professionals are fixated on investments. You should be fixated on achieving the outcomes that you want. The investments are just a means to an end.

Lamonica: And then another issue is that using a professional's pick in the media is not generally something where you get a lot of context. So we can have an investment manager that says they like CBA right now in an article. That's great. But CBA may make up 0.5% in their widely diversified portfolio. They almost never share those details and many professionals have very short holding periods and nobody's going to write another article when they sell the position.

Jayamanne: Well, now that we've gone on and on about the dangers of listening to professional picks, is there any good reason to use them?

Lamonica: There is. And it's about idea generation. There are tens of thousands of choices out there for investors and it can be really time consuming to narrow that all down. But I do want to be clear that it's a jumping off point. It is an option you assess if that pick that you read about is right for you, for your investment strategy and for your goals.

Jayamanne: So why don't we run through an example?

Lamonica: All right. Sounds good. So I will read out an example and then you, Shani, can walk through the exercise of evaluating it.

Jayamanne: So I do the hard work.

Lamonica: Yes.

Jayamanne: Okay.

Lamonica: I think that that's fair.

Jayamanne: Just so we can clarify that.

Lamonica: Okay. So the AFR wrote an article titled Macquarie says it's time to buy real estate stocks before rate cuts. And the article quotes a report put out by Macquarie. And here's a rationale quoted in the article for Macquarie's view that it's time to buy real estate investment trusts. And to be clear, I have not read the report. I guess I could probably get access to it. But the whole purpose of this exercise is for everyday investors that read the financial media and try to make decisions based on what they read. Okay. So here's what I read in the AFR. With the U.S. Federal Reserve expected to cut in September, we would look past the risk of an RBA hike and are now overweight REITS. We expect a hawkish shift from the RBA and it has happened. With the shift to slow down and global banks easing, there is reason to think the RBA will hold, so as not to risk pushing the Aussie dollar up too far.

Jayamanne: So a nice complicated one.

Lamonica: Exactly. So where do we start, Shani?

Jayamanne: Alright, well the first thing we need to do is figure out what they are actually saying, because these things are generally filled with jargon. Macquarie is talking about REITs. A REIT, or a real estate investment trust, owns real estate, rents it out and profits off the difference between the cost of maintaining and holding the real estate and the rents taken in. So it's a pretty intuitive business model. To buy or build real estate is expensive and many REITs use debt to fund the purchase or construction of property. The cost of that debt is impacted by interest rates and Macquarie is saying investors should ignore the talk of short-term RBA interest rate increases and focus on the fact that they will come down eventually. If interest rates come down, it can be cheaper to service the debt. Lower cost means more profits.

Lamonica: Okay, so that makes sense, but underlying this call is their view of the direction of interest rates. So let's dissect that a little bit, because while Shani has outlined why a REIT benefits from lower interest rates, this call only makes sense if that actually happens. So why does Macquarie think interest rates are coming down in Australia?

Jayamanne: Macquarie is essentially saying that no matter what happens in Australia, the RBA will be forced to act because the Federal Reserve is going to cut interest rates, which will put upward pressure on the Aussie dollar.

Lamonica: Now, it's obviously great to listen to experts, but we need to believe they are right. If we want to follow their call, this is where we need to do some research. So to validate Macquarie's opinion, you have to consider the following. Will the Federal Reserve cut interest rates in September? Will a cut in U.S. interest rates push the Aussie dollar higher? Will the RBA respond to a higher Australian dollar with a cut of interest rates no matter what is happening with the local economy and local inflation?

Jayamanne: Okay, so a lot to figure out. And this is a pretty complicated call because it's not only predicting the macro level event, but then attaching it to a certain security.

Lamonica: But what is important is how this fits into your individual investment strategy. So what do you think, Shani?

Jayamanne: All right. Well, I've been quite vocal about my investment approach. I'm much more focused on my savings and getting money into the market and making sure I'm getting my asset allocation right and minimizing taxes and fees. So I'm generally not going to buy an individual REIT.

Lamonica: Okay. So what about like a REIT ETF?

Jayamanne: Well, as I said, I'm very focused on asset allocation, particularly between growth assets and defensive assets. So I'm not going to buy a REIT specific ETF. I get exposure to REITs from index funds, and I particularly get a lot of exposure to real estate from my super fund, which allocates a fair amount to real estate.

Lamonica: So basically what you're saying is that this is an easy call for you to ignore. So whether Macquarie is right or wrong, it doesn't matter to you.

Jayamanne: Exactly. But let's run through one more example, and you can answer the questions this time, Mark.

Lamonica: Okay. I think that's fair. You did do the first one. But before we move into our next example, just a reminder, if you want to hear the top five global market updates from around the world, click the link in the description for 5 in 5 with ANZ podcast.

Jayamanne: How unnatural is it for you to say Z?

Lamonica: I mean, I've lived here for 10 years.

Jayamanne: Okay. So you got the ANZ down pat?

Lamonica: Well, yeah, I know the name of the bank.

Jayamanne: Okay. All right.

Lamonica: It's less natural it's just a letter.

Jayamanne: Yeah. That's fair. Okay. My next example is also from the AFR in an article published on July 1st titled GQG slashes tech exposure. Here's where it's buying next. I'm going to focus on the buying next part. So the article has several quotes from GQG's Brian Kurzman. We've seen staple stocks trading at 52-week lows because they had a multiple (indiscernible) rating falling from around 29 times earnings. As people realized, they didn't want to pay a premium for safety because a recession wasn't happening. Now, these companies are priced more attractively with their multiples in the mid-teens, and so a basket of these stocks looks like they're at some of the lowest premiums to the market that we've seen in a very long time. So, Mark, what's your take?

Lamonica: I mean, my first take is he probably could have said all that with like four words. But anyway, let's go through Brian's hypothesis. So it's focused on valuation. He says that these companies have gotten too cheap. He mentions a recession, but that was in reference to overall investor expectations changing from thinking a recession is imminent to the view that we will avoid one. So Brian isn't making any predictions about the economy. He is just saying that investors have done something they do countless times, overshooting the appropriate response to changing views of the economic environment. And as I said, we see this all the time when times are good, investors get too optimistic. When times are bad, investors get too pessimistic. Brian didn't say it, but I think his expectation is that since valuations are so low, they will naturally go up, even without a catalyst. This is a much easier opinion to do further research on since he has isolated his call to one factor and isn't offering any sort of macroeconomic directional call.

Jayamanne: So how do you evaluate this against your investment strategy?

Lamonica: Yeah, I mean, honestly, I think that it's kind of right in my wheelhouse. So as I've talked about in here, I like consumer staple shares. I own a lot of them. They're non-cyclical, which I like. They generate healthy cash flows, which also means they pay healthy dividends. I like all of that. So this is a good sector for moats. So they come generally from cost advantage and tangible assets. And I of course want shares with moats that compound internally generated and invested funds over the long term.

Jayamanne: And I think this is a perfect example of how these views can be really useful. Say what you want about fund managers, but they spend their days looking at the market and dissecting what is happening. Many of us don't have the time to do that. So when they make these observations, they can be really valuable. But of course, you need to do your own homework or send it to Mark by email.

Lamonica: Exactly. But yeah, so if we look at GQG, if you haven't heard of them, they are a global equity fund. So the first thing I do is I do a quick check of global consumer staple shares and see how much valuation levels have fallen. Then you need to start going through a list and doing research. Even though Brian is only focused on valuation levels, something going wrong with one of the other two drivers of returns could derail an investment in an individual share. Valuation level isn't going to go up if you pick the wrong company and earnings drop or the dividend is cut.

Jayamanne: So here's one last question for you, Mark. We publish a lot of articles that have picks from our analysts and we of course sell access to our research. How is this different than the traditional media coverage we've discussed and how can investors use this?

Lamonica: Yeah, I mean, I think the big difference is that we provide a complete research report and explanation in our articles that fully account for why our analyst has a particular view. An investor should still go through the same steps we've outlined. Figure out if this is the right share, ETF, or fund for you. Figure out if it fits into your investment strategy. Figure out if it can contribute to achieving your goals. And this is a lot easier to do when you have the complete picture than if you have just a quote or two in an article. So I do think it's easier to use the stuff that we put out, but of course an investor will still need to figure out if it's right for them.

[Advertisement: Investing Compass is a podcast we started to explore the fundamentals of investing and help you with achieving your financial goals, whatever they may be.

You can find them in your preferred podcast player or click the link in the episode description to follow them and have a listen after us.]

Lamonica: And that is today's episode. Thank you for listening. Shani has already zoned out and is currently staring at her phone because she makes me do all the outros, but we really appreciate you listening to the podcast.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)