A- A A+

The myth of stock picks

David James |  01 April 2015  |  Investing

mythWhen people think they know better than the market, they are making a big leap of faith in themselves. Because it is them versus, usually, millions of others. As this article in the AFR points out, the notion of a stock tip rests on the idea of specialist knowledge. But does such knowledge even exist?


Share tips are a great Australian tradition, whether they're passed on by your brother-in-law at a dinner party or by a stranger in an online chat room. The obvious problem for investors is: do you just take the bait?

"Always remember, when you buy a stock, someone else has to believe just as passionately that it's a sell," says Elio D'Amato, chief executive officer at financial research firm Lincoln Indicators, which operates the Stock Doctor fundamental analysis subscription website.

"Investment requires a lot of work and following tips from a workmate is just not going to work. You might get the odd one right through sheer luck, but it's not going to make you money in the long run."

D'Amato says investors have to understand the business behind the stock, what it's worth and what its risk level is. But even before that, he says they have to understand what kind of investor they are – a trader or a long-term investor.

For a start, investors have to understand the share price "means nothing", he says, other than what entering the stock will cost you. Nor does the usual method of expressing a stock's risk, its standard deviation measure (volatility of the share price around a mean). "When it comes to risk, the actual risk of an investment is the financial risk of the business."



Even the idea that you have to do a lot of hard work to get things right is questionable. Remember, there are many opinions that go into making up a stock price. Are all of them worse than yours?


Skaffold uses consensus analysts' forecasts for future cash flows, earnings and dividends. "While that's not perfect, we try to get input from a range of experts in the market and look not just at the average but also the range," Batchelor says.

"If there is a wide range, you know there's not a lot of confidence in the forecasts, whereas a tight range implies a reasonable degree of predictability about this business. You can be a lot more confident in whatever numbers come out of your model."

The idea is also to capture growth prospects, he says. "It's one thing to say this business is at a discount to its intrinsic value today, but you also have to know what are the prospects for that business going forward. What if it's low-growth? We might be prepared to pay more for a business if it has great growth prospects than we would for a business that is just steady."

Batchelor agrees standard deviation of the share price "doesn't tell you a whole lot" about the intrinsic risk of a business. "We're certainly interested in volatility, but to us that means the volatility of the company's earnings. Woolworths is much more steady in its earnings than an iron ore miner is."


It is nice to pick the right timing to enter the market. But there are limits on all stock picking, limits that come with being only one person amongst many in the market trying to get it right. And even those 'value' calculations are only based on historical data, they say nothing about what matters -- the future.


Source articles

Similar articles from Investing

Is the Future Fund telling us something?

David James | 4/28/2015

attentionThe Future Fund, which funds the superannuation of Australian public servants, is withdrawing from the market claiming it is over priced. Meanwhile, the RBA governor warns about the perils of chasing yield.

Should wealthy superannuants be taxed?

David James | 4/26/2015

ideaThe current focus on 'wealthy' superannuants may have some justification, but the big problem lies elsewhere -- the tax rorts in the property market.

BHP and its dividends

Staff writer | 3/30/2015

BHPBHP Billiton is one of the world's resources giants and is a behemoth of the local bourse. Analysts believe it is fully priced, but it may also be attractive for its dividend, which is unusual for a mining company.

The flat lining Australian stock market

David James | 3/22/2015

FlatWhy is the Australian stock market going nowhere when world stock markets are rising? The answer is probably the concentration on dividend yield in the domestic market.

Mr Henry does something curious

David James | 3/19/2015

yieldThe former head of the Treasury, Dr Ken Henry, has made a curious investment observation. He has questioned investors focusing on yield.</p,



Subscribe to the Personal Super Investor weekly email to keep abreast of developments in SMSF law and investment markets. SMSF investors looking to improve investment returns from shares, property, cash or other specialised investments, will find the PSI weekly newsletter an invaluable resource.

Subscribe now »



The contents of this website are of a general nature only and have not been prepared to take into account any particular investor's objectives, financial situation or particular needs. Our content is not intended to be advice and must not be relied upon as such. You should seek independent advice tailored to your specific circumstances prior to making any decisions. Personal Super Investor does not provide financial product advice or recommend any financial products: Where this website or it derived newsletter/electronic publication refers to a particular financial product, whether it be within our editorial or a 3rd party advertising, advertising promotion or advertorial, then you should obtain a Product Disclosure Statement (PDS) relating to that product and consider the PDS before making any decision about whether to acquire the product. We also recommend that you should seek professional advice from a financial adviser before making any decision to purchase any financial product referred to on this website. We do not make any representation or warranty that any material on the Personal Super Investor website will be reliable, accurate or complete, nor do we accept any responsibility arising in any way from errors or omissions of our content or any content provided by any advertiser appearing the Personal Super Investor website. We will not be liable for loss resulting from any action or decision by you in reliance on the Material (whether editorial or advertising) on the Personal Super Investor website, nor any interruption, delay in operation or transmission, virus, communications failure, Internet access difficulties, or malfunction in your equipment or software. By using the site you acknowledge that we are not responsible for, and accept no liability in relation to any content contained on the site that you may use, including any other users’ use of the Personal Super Investor website in any circumstance. You use the Personal Super Investor website at your sole risk.