Transcript
Myths of Investing 1: Stock Picking
Paul Winkler: Okay. So, myths of investing, you know, so this is something that we talk about quite frequently. And you know, when we do workshops, this is one of the things that we try to do is we try to break people of these patterns. You know, it’s pattern patterns are, you know, it’s hard because the patterns that investors tend to face tend to be the things that are dysfunctional, but they’re hard to break because they’re hard wired into our brains in our psyche. And one of them is stock picking stock selection, which companies do we think are going to do well going forward, you know, because we read the tea leaves or we look around and we go, okay, so what’s going on?
Oh, you know, you know, we might have a change in energy policy. Let’s say, you know, if we have a change in energy policy, which companies are going to be the losers, which companies are going to be the winners in that we might have a change in how car manufacturing takes place and maybe we’ll have more electric cars going forward in less fuel driven gas driven vehicles going.
Jim Wood: Yeah, certainly. Yeah. With the election. Well, the policy of this candidate versus the policies of that candidate, which, you know, how should we change our portfolio to take advantage of so-and-so’s possible legislation that they might do. I mean, you see all kinds of stories regarding that and which should just, you know, just, well, I guess somebody had to turn in some words, so they recycle the same bad ideas over and over, but why would you be changing anything based on what somebody who might get elected might do. Right.
Paul Winkler: And that’s what happens with companies. We look around and say, who is likely to benefit from this? And let’s start down at the micro level. You might work for a company and you work for that company and you think, you know, the company inside and out, and you may, you may know a lot about the company, but the issue is, do you know more than even, let’s say the CEO of the company, unless you’re the CEO, then you probably know just as much as the CEO, but do you know more than those, those people that are in leadership in the company, number one, number two, do you know the coming trends that are going to be completely outside of your control that will affect your company?
You know, maybe somebody that’s competing with you unbeknownst to you, that’s working out of their garage right now coming up with a better solution or whatever your company is, whatever is your company. Do you know the legislation? That is definitely, absolutely no question about it coming out of Washington that may affect you from a regulatory or a tax standpoint and how that will affect, do you know it before it gets passed? Do you know it before it actually becomes, maybe somebody actually suggests it or it is put out there for debate. Do you know that information beforehand? If your assumptions are right, you might have all the information on the company, but you might be interpreting it incorrectly.
Companies Are Dependent
Yeah. You do. You know, let’s say I was thinking of one company that I knew and it was interesting. Their product was actually very dependent upon petroleum costs. Yeah. And they had to know, you know, they had to know what it was going to cost in order to actually put their product together. Another company I can think of right off the top of my head, they were very dependent upon copper prices. So you have to be dealing with our countries that actually produce any of these things or supply, let’s say raw materials, not just copper or petroleum, but you know, just any material that you can think of, you know, are there going to be any trade barriers erected against these companies?
What companies that actually supply your company with products, you know, maybe the raw materials or the manufactured goods that go into making your product, how are they going to be affected by trade barriers or maybe moving from one country to another? Or maybe let’s say all of a sudden labor costs go up. I know. So now, since there’s so many things you just think about, I’m just randomly, randomly coming up with things off the top of my head and know you think about what we just mentioned, the virus. So, how does that affect people? How does that affect companies? Who’s gonna win. Who’s gonna lose weight. You’ve got to know how companies are going to respond to it from a standpoint of, you know, how competitively they will respond to something, how they adapt to the new circumstances, how quickly do they adapt?
Right. So many things to predict. It’s just impossible. So how do we judge, whether people have the ability to pick stocks, what we look at the data on it. We look at the data on investment managers in various areas of the markets. So if you have an investment manager that says, okay, there are approximately 500 large US companies and we call it the S&P 500. Okay. So the investment manager’s job would be well out of those 500. They must not all be great. There’s gotta be maybe a handful of, you know, minimum that a fund can own is 20 stocks. So there’s gotta be at least 20, 30, 40, 50, 60 companies that are really good out of all those companies.
Company Performance Versus the Market
So let’s just look at their performance versus the market. And what we see is you’ve heard me say time and time again, 93% of them underperformed the market over the past 15 years. And then we looked at day traders and wasn’t, well, they’re, they’re not, they’re not, they’re not subject to that 20 stock limit. You know, so let’s look at their data. And it was like something, what that Brazilian study was 3% of them and only 3% of made money. It was, it was pretty, pretty abysmal. And there was another study that was done in, in another country. That was, it was interesting. There was a study done in the United States once, and the results were so bad that they never reported the data. Again, they are smart enough. These online firms are really smart enough.
They don’t even report the data. There was one professor that actually got a hold of it though. I actually covered it in my book. I forgot what the data was, but it was pretty bad. So, that’s what we look at. We can look at small companies and it’s 97% underperformance. So, you know, stock selection. That is, that’s a myth.
Jim Wood: Well, the thing about stock selection is it’s not zero cost. It costs money to do all this research, to visit the companies, to try to get that information that you think you need to give you an edge on making a good decision on, do I buy this company or do I sell this company and try to add performance, avoid risk or both? But every time there’s buying and selling and moving that around, then there’s some friction, there’s some costs that come off. And so that’s at least one of the reasons why it is so difficult for managers who participate in that type of investing to just get, even with market returns, let alone outperform the market.
And the longer that they try to do it, fewer and fewer and fewer actually succeed. And it’s much less than would be expected if they were all sitting around flipping coins.
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Underperformance
Paul Winkler: That’s what it’s actually called a hurdle rate. There’s a term for it. Now people think because they see commercials, they see, you know, articles out there. They read things. They don’t realize that they’re reading biased information on the internet, but they think that the only expense is the small commission or even non-existent commission with many funds out there and the management fee of the funds. So typically what happens is they become fooled into thinking that they are, you know, Hey, this is a, this is lower expenses. And here’s something, Jim, I want to bring up something because this is something I’ve seen. I’m sure you’ve seen it as well. If somebody has a fund that has underperformed and it has underperformed, some other area of the market, have you noticed this, that people tend to go, the underperformance is due to the expense.
That’s what they blame it on. When the underperformance was not due to the expense, it was due to what area of the market the fund happened to be more focused on.
Jim Wood: Yeah, absolutely. And, they’ll blame that on the expense, which, you know, it might be an outrageous expense depending on the fund or something, but that’s not necessarily the reason that might be additional weight on that fund. And especially if there’s a ton of trade going in, it’s got a high expense trading done in the fund. If it’s got a high expense ratio.
Paul Winkler: Yeah. That’s, that’s what they typically focus on. Yeah. Because I’ve noticed that because I’ve seen funds out there that are really, really low cost. And I’ve seen other funds that were there, there was a little bit more thought going into how the portfolios were managed
Jim Wood: And people will have that kind of intuitive, Oh, this fund is underperforming because it’s, you know, extra expensive or something like that. And you ask them, well, what’s the expense ratio. What’s that fun paying though. I don’t know. It’s true. You know, but it’s, so it’s something that you can intuitively feel in part, because that’s one of the messages that you get from the financial media.
Paul Winkler: That’s right. And it’s so funny, you say that it’s from the financial media and you find, I routinely. And I talk to people on both conservative and liberal side of the fence. And you know, what’s really funny now. Right. Right now. And I’ve, I’ve done this with a lot of people lately. It’s just, just talking and random with people and just getting their opinions. It’s really fun to hear what they have to say, what I’ve found routinely.
Okay. So stock picking, trying to figure out which companies are going to do better than others—another myth of investing.
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