Want to beat the market? You have to be ready to buy stocks that no one else wants. Not many companies are willing to. To find out if you are, ask yourself which of the following stocks you would be most likely to buy:
One stock that has gained 174.1% so far this year and has a historical price/earnings ratio of 56.6.
- A stock that has lost money over the past year and is down 59% this year but doesn’t have a price-to-earnings ratio.
This is what most buyers would do: they would pick the first stock. Another study says you are more likely to do better with the second one.
These two stock images are real. Nvidia NVDA owns stock number 1. 4.14 % New York Community Bancorp (NYCB) owns Stock No. 2.
There will be a name change at NYCB -4.02% on October 25, the same day that the company reports earnings for the third quarter.
If it’s hard for you to imagine passing up Nvidia—which is the talk of the AI world right now and riding a wave of huge popularity—in favour of a bank that’s still trying to get back on its feet after going bankrupt, then you probably aren’t a contrarian trader.
When it comes to betting on turnarounds, the best investment newsletters that my auditing business keeps an eye on easily beat out the crowd favourites. In fact, this new study says it’s not a coincidence that they do so well. At the moment, three of them are suggesting NYCB.
The study was called “Finfluencers” and was done by Ali Kakhbod and Dmitry Livdan from the University of California, Berkeley; Seyed Kazempour from Rice University; and Norman Schurhoff from the University of Lausanne. “Finfluencers” is short for “financial influencers,” which are “people who give free investment advice on social media platforms.”
The study looked at the stock suggestions made by 29,000 finfluencers on a big social media site from 2013 to 2017. They discovered that most of their suggestions did not beat the market. In fact, 16% of the financiers were judged to have “no ability,” which means they were neither winning nor lagging, and 56% were judged to have “anti-skill,” which means they were significantly lagging the market.
It’s typically hard to beat the market, so these results don’t come as much of a surprise. However, one of the study’s other results was very interesting: “anti-skilled” finfluencers have a much larger following than skilled ones. See the graph above? There is a strong negative relationship between the number of fans an influencer has and their chance of beating the market.
To put it another way, being a radical is lonely, and not everyone can do it. Many, if not most of us would rather be in sync with the crowd and do what everyone else does than question what everyone else thinks, even if it means we do about average. We’d rather fail in the usual way than win in the unusual way, even though most of us don’t like to say it.
Stock picking and horse racing
To make money with a stock, it isn’t enough for the company to turn a profit; it must beat investors’ expectations.
There are a lot of people who don’t think this is true because they think that companies like Nvidia will make more money next year than companies like New York Community Bancorp. They’re probably right, too. But for investors to make money on a stock, the business must do more than just make a profit. It must also do better than what investors expected.
Since Nvidia’s stock is almost perfectly priced right now, the company could report huge gains in the next few months, but still fall short of expectations, which would cause its stock to fall. On the other hand, investors have very low hopes for New York Community Bancorp right now, so the company won’t need to do very well in the business world to surprise everyone to the upside.
An comparison with a horse race can help you understand this point: Imagine a race with 10 horses, and you can bet on any of them. One of the horses is a crowd favourite and is expected to win, while another is expected to come in last. Let’s say that the horse that everyone likes comes in second and the horse that no one likes comes in seventh. It’s likely that you would win more money betting on the seventh-place horse than on the second-place horse, even though the second-place horse was much faster than the seventh-place horse.
