When is active stock picking a good idea?

[rsliu]

I work in the investment industry, and based on what I've seen for almost all individual investors you are much better off putting your money into some combination of Vanguard index funds rather than trying to pick stocks on your own. The basic reason for this is that when you make active stock picks you are basically competing against thousands of smart, dedicated equity analysts who spend their waking hours thinking about stock prices. To make things worse, these people usually have more information than you.

However, lately I've been thinking that there is one exception to this rule: when you have a better understanding of consumer tastes in a certain industry than the analysts. It seems to me that the analysts are very good at understanding corporate balance sheets, but there is no reason to assume they are intrinsically good at guessing what products will do well. For example: I play a lot of video games. I think I have a reasonable intuitive sense of what the big trends are in gaming, and which yet to be released games will become blockbusters. My friend does equity research in the tech sector at Morgan Stanley. She does due diligence on video game companies, but does not play them herself. So if her growth projection for a company is based on, "This company is releasing an MMO, let's look at how these other MMOs did and make a reasonable estimate", while mine is based on, "This company is releasing an MMO but is doing none of the subtle game design and implementation things that make WOW so popular", it certainly seems possible that I will come up with a better projection. And if I can come up with a better projection than these analysts, and the opinion of these analysts largely determines the stock price, then I should be actively trading individual companies.

I have not tested this idea but I am curious to see if there are any obvious problems with it.

[PokerFox]

My only problem with that is, you're like "wow this game/product/design etc is AWESOME and everyone will play it." so you invest in the stock, and that game IS awesome, but the rest of the company blows (in terms of marketing the game, distributing it, producing it, maintaining competitive market share, etc), and if you go based solely on the product it is releasing you will get hosed at least once or twice.

Only people who don't start investing till they are 30-40 and NEED 20% returns should be investing in single stocks, IMO. 11% annualized with reinvested dividends and boom, millionaire retirement.

[rsliu]

So those other factors you cite are exactly the things that equity analysts do well. In theory, those should be priced into the market already. Therefore, if I assume the market has correctly discounted the fact that company X blows, but hasn't correctly perceieved that company X has an awesome game, then I should buy company X knowing full well that it's a terrible company.

Your second point is just flat out wrong. Your investment strategy is always dictated by a combination of your risk preferences and the ratio you can achieve through different vehicles. For example, I'm 22, have a stable job, and project strong income growth. There is absolutely no reason why I should not be aggressive about risk in determining my 401k allocation. And if I think my ratio as an active stock picker is better than what I can get in a Vanguard SP index, then I should do it.

[DesertCat]

There are many stocks uncovered by "smart, dedicated, analysts". Sell side analysts are compromised by trying to curry favor with the company or their superiors at an investment bank. Analysts working at mutual funds are handcuffed by restrictive rules on what they can buy, and having to publicly announce their best ideas. So there are a few super smart guys at hedge funds who can't cover the entire market.

There are many opportunities out there. If you understand value and work hard at it you should be able to beat the market.

[Sand]

[ QUOTE ]
There are many stocks uncovered by "smart, dedicated, analysts". Sell side analysts are compromised by trying to curry favor with the company or their superiors at an investment bank. Analysts working at mutual funds are handcuffed by restrictive rules on what they can buy, and having to publicly announce their best ideas. So there are a few super smart guys at hedge funds who can't cover the entire market.

There are many opportunities out there. If you understand value and work hard at it you should be able to beat the market.

[/ QUOTE ]

Pretty much. The market is emotion driven. Stocks will vary widely from their intrinsic value. Witness a stock like MO after the lawsuits a few years ago, for example. Major overreaction by stockholders - it has tripled since.

Lots of value out there, but it is emotionally difficult for many investors to buy JNJ when things like HANS are the hot items splashed all over CNBC. When I look at individual stocks I like to see a history of dividend growth (20+ years) and a discount from intrinsic value (for what it is worth - there are lots of ways to make money out there).

[hawk59]

Your strategy is making the mistake that most investors/analysts do and that is that they consider quarterly numbers to be very important. It's just a product of psychology, ie stocks tend to move significantly in one direction or another when quarterly numbers are released or guidance is changed, therefore figuring out what the quarterly numbers are going to be is what you need to do to be successful. But that is wrong, and the focus on quarterly numbers is what makes a lot of opportunities available if you take a view on what the company is actually worth.

[DesertCat]

[ QUOTE ]
Your strategy is making the mistake that most investors/analysts do and that is that they consider quarterly numbers to be very important. It's just a product of psychology, ie stocks tend to move significantly in one direction or another when quarterly numbers are released or guidance is changed, therefore figuring out what the quarterly numbers are going to be is what you need to do to be successful. But that is wrong, and the focus on quarterly numbers is what makes a lot of opportunities available if you take a view on what the company is actually worth.

[/ QUOTE ]

I rarely watch CNBC, but there was a good example of your point yesterday. A reporter breathlessly gushed how extremely cheap USG was getting again, close to where Buffett had been buying it in large volume just a few months ago. But when he asked other investors/analysts they said something akin to they didn't think USG was going to move this quarter (due to housing market slump), so they were going to wait until the end of the year or next year to buy.

[PokerFox]

[ QUOTE ]

Your second point is just flat out wrong. Your investment strategy is always dictated by a combination of your risk preferences and the ratio you can achieve through different vehicles. For example, I'm 22, have a stable job, and project strong income growth. There is absolutely no reason why I should not be aggressive about risk in determining my 401k allocation. And if I think my ratio as an active stock picker is better than what I can get in a Vanguard SP index, then I should do it.

[/ QUOTE ]

To each his own. If you think you NEED 20+% returns, by all means, be more aggressive. There is a price to pay as you know.

I'm virtually guaranteed to be a millionaire when I retire with some of the smallest risk you can take, as far as the market goes.

I know you think you have the market cornered, but I'm telling you, consistent returns of 11-14% are more than adequate.

But again, to each his own. GL sir.

[kimchi]

[ QUOTE ]


I'm virtually guaranteed to be a millionaire when I retire with some of the smallest risk you can take, as far as the market goes.

I know you think you have the market cornered, but I'm telling you, consistent returns of 11-14% are more than adequate.


[/ QUOTE ]

Consistent returns of 11-14% are more than adequate, but where do you get your "guarantee to be a millionnaire" from? What is it you're investing in than is so sure?

[TheMetetron]

[ QUOTE ]
[ QUOTE ]


I'm virtually guaranteed to be a millionaire when I retire with some of the smallest risk you can take, as far as the market goes.

I know you think you have the market cornered, but I'm telling you, consistent returns of 11-14% are more than adequate.


[/ QUOTE ]

Consistent returns of 11-14% are more than adequate, but where do you get your "guarantee to be a millionnaire" from? What is it you're investing in than is so sure?

[/ QUOTE ]

I'm 90% to be a millionaire by the time I'm 35 in just retirement accounts. Unless the entire world's economy goes crashing down.