Why are stock picks in the media usually red hot?
Professional managers are under constant pressure to save face and grow the assets under their control. Can the small investor benefit?
I don’t know about you, but I spent a decent chunk of my holiday downtime reading about investing.
Given the time of year, a lot of the fresh content out there centered on what the author (or those featured in the article) thinks will happen in the new year. You might have read a few of these articles on Morningstar or Firstlinks too.
I’m not much of a macro guy and think that predictions on this front – recession or no recession, rate cut or no rate cut – are often a fool’s errand. As a result, I am far more disposed to reading about the outlook for individual industries or companies than the economy as a whole.
Over Christmas I was sitting by my local pool reading one such article – a list of best Aussie and global stock ideas – when I noticed something. Have a look at the anonymised list of picks below and see if you notice it too.
- A healthcare stock up 45.60% in the past year at the time of writing
- An industrials stock up 34.87% in the past year
- A communications stock up 36.46% in the past year
- A financials stock up 33.89% in the past year
- A technology stock up 21.58% in the past year
- An industrial up 69.16% in the past year
- An industrial up 19.95% in the past year
- A communications stock up 136.96% in the past year
- A mining stock up 35.92% in the past year
- A healthcare pick up 102.08% in the past year
Did you see what I did?
Every single pick shot the lights out last year. Every single one! All ten whipped the ASX 200. All but two of them smoked the S&P 500’s already massive return in 2024. The average yearly gain for this group of companies at the time of writing was 53.65%. Good going.
Of course, a stock doing well recently doesn’t preclude it from performing even better in the future. These companies might still offer fantastic value today. I think it’s telling, though, that the list didn’t contain a single loser from the past year. Why is this?
It isn’t due to a lack of candidates.
Although it may seem like everything went up last year, over 70 stocks in the ASX200 posted a loss. Add in some losing Aussie small caps and 170+ losers from the S&P 500 (let alone Europe) and there were plenty of clinkers to pick from.
One explanation might be that the managers were sagely buying or adding to names that didn't perform so well last year, and didn't want to ruin the prices they were getting. But I think there were a few other things at play too.
Keeping up appearances
Fund managers appear in articles like this because they want to look smart to clients and potential investors that are reading. If they are asked to talk about a company they have picked for their portfolio, they are more likely to choose one that has done well.
This is especially true if they know that other fund managers are going to appear in the article and are probably going to talk about one of their winners.
Who would talk up the long-term merits of Santos (down circa 10% last year) when the competition are likely to mention something that doubled?
Safety in consensus
As a whole, I think the list also exhibited our tendency to seek cover in crowds. If most other investors also thought that X company had everything going for them, you aren’t alone in looking silly if things don’t turn out as hoped.
People will think you just got unlucky. Get it wrong while swimming against the consensus, though, and you will not be viewed as unlucky. You will be seen as getting something wrong that was plain and obvious to everybody else.
Extrapolation
I think the universal preference for recent winners also showed a tendency to put a lot of weight on recent trends when it comes to predicting what will happen next. But economies, industries and companies don’t progress in straight lines.
In cases where everything has been going well recently, assuming that this will continue unabated (or at an even faster rate) can put an investment at risk of being priced for perfection.
This may not be the end of the world for existing holders who bought in a lot lower. But it might not be a great time to enter a holding.
It’s also worth remembering that a poor short-term outlook and a perfectly decent long-term outlook are not mutually exclusive. Thanks to our tendency to extrapolate, shares in companies like this can become available at prices that suggests things will only get worse.
A behavioral edge?
For what it’s worth, I enjoyed the article in question. It was a good read. Individually, the picks and the analysis were interesting and fairly compelling. A few even sounded like the kind of company I’d like to own one day.
Collectively, though, I think the group of companies showed some of challenges that many professional investors grapple with. The risk of taking a different standpoint from the crowd. The fear of catching a falling knife in public. The attraction of having a portfolio that is in fashion and easy to justify.
As individual investors, we do not need to worry about these things. Even better, we can try to turn them to our advantage. Indeed, a big addition to my investing process recently has been a requirement to identify where I think my edge is coming from.
If you want to learn more about the four potential sources of investment edge (and the only two that we think really apply to individual investors) take a look at Step 3 in this investing strategy guide by my colleague Mark LaMonica.
