Why I can’t pick winning stocks, and you can’t either

Don’t feel bad.  Most pros can’t either.

 Indexing vs. active management is always a fascinating debate; at least for us stock geeks with nothing better to do.  Over the decades I’ve been on both sides of it at various times. For a very long time I laughed –ha, ha, ha, ha — at the indexers.  I made all of the arguments, and then some.

 After all, if you just avoided the obvious dogs you’d do better than average, right?  Who would be stupid enough to own GM a couple of years ago?  Or Ford?  Opps.  Better forget about Ford.  Hindsight is a beautiful and perfect thing.

Convinced I could win this game, after all I’d just bought a stock that tripled, I even took a major pay cut to join an investment research firm mid-career.  http://jlcollinsnh.wordpress.com/about/ There I was, surrounded by exceedingly bright people.  Each focused on one, maybe two industries and perhaps 6-10 stocks.  More than one had been honored in the trade press as “Analyst of the Year” for their work.

They knew each of these companies inside and out.  They knew the top executives.    They knew the middle-managers and the front line people.  They knew the customers.  They knew the suppliers.  They knew the cute receptionists.  They spoke to them all weekly.  Sometimes daily. 

They still didn’t get info before anyone else (that’s insider trading, fool proof and, ah, illegal).  But they did know exactly when and how the info would be released.  Of course, so did every other competent analyst around the world.  Any new information was reflected in the stock price within minutes. 

They issued reports our institutional investor clients paid dearly for.  And yet, predicting stock performance remained frustratingly elusive. 

If you’ve worked in a major corporation it is not hard to see why.  The CEO and CFO work with internal forecasts from their teams.  The process looks something like this:

 Salespeople are required to forecast what their customers will spend.  Since these buys are rarely locked in far in advance, and can be cancelled anytime, nothing is certain.  Add to this all the pending business that may or may not come to fruition and basically you are asking the field salesperson to predict the future.  Typically they are not clairvoyant.  So, of course, they take a guess.

These guesses get passed on to their managers, who are also not clairvoyant, and who now have their own forecasts and decisions to make.  Do I take these sales forecasts at face value?  Do I adjust them based on knowing Suzy is an optimist and Harry always sees dark clouds?  So, of course, they take a guess and pass it on to the next layer of management.

So it goes until all these guesses on the inherently unknowable future are consolidated into the nicely packaged budget/forecast binders presented to top management.  More often than not, after one look, they’ll say:  “This is unacceptable.  We can’t present this forecast to Wall Street.  Go back and revise these numbers.”  Back down the chain it goes.  Maybe multiple times, and each time the numbers get a bit further from reality.

Now predicting the future is a dicey proposition for even the most gifted psychics; and they are not burdened with this process.

Suddenly my enormous stock picking hubris was clear.  Somehow reading a few books and 10ks was going to give me an edge?  Over not only the professional analysts who lived a breathed this stuff all day every day, but also the executives who run the companies in question?  I could succeed where they could not?

Suddenly I realized why even rock star fund managers find it almost impossible to best the simple index over time.

There is a reason names like Buffet and Lynch are so revered and well known.  There are also reasons more fortunes have been made brokering trades than making them.

That’s why I’m now an indexer.  If you choose to try to best the averages, God Bless and God Speed.  You may well be smarter and more talented than I.  You are most certainly likely to be better looking.  I’ll look for your name along with Warren and Peter’s in the not too distant future.

I extend the same to all those folks I’ve met in Vegas who assure me they have bested the house.  I listen, gaze up at the billion dollar casinos and reflect on how many smarter, more talented and better looking people there are than me.

Oh, and that stock that tripled?  Well, even a blind squirrel……

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