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……

Care to comment?  Just click on the circle on the top right of the post.

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  1. Posted January 2, 2012 at 10:19 pm | Permalink

    Yep, those glittering Vegas palaces were all funded by people who thought they could beat the house. Of course if you head over to the Poker room, you’ll find people who can win consistently with skill, because they have found ways to invest their money in situations where they have a statistical advantage.

    Most Poker players also lose, admittedly. But some win – year in, year out.

    • Posted January 2, 2012 at 11:11 pm | Permalink

      The key to poker in Vegas is that, unlike any other game, you aren’t playing against the house.

      as I describe here: http://jlcollinsnh.wordpress.com/2011/07/01/johnny-wins-the-lotto-and-heads-to-paris/

      I used to play in a regular game in Chicago and made a pretty good dime or two in the process. It is the only “gambling” I’ve ever enjoyed because:

      1. It is a game of skill. Statistically, every player will receive the same number of winning and losing hands over time. The guys who walk out with the money are the guys who know which is which and how to play them.

      2. I didn’t have to be the best player at the table to make money. This was important as I was rarely the best player. In poker the top two or even three players take home the cash.

      I remember playing in a high stakes game in Vegas for the 1st time. It became clear quickly that four of the eight seats were occupied by pros. They spent the night cleaning out the tourists who’d sit down for the 20 minutes or so it took them to bust out.

      The pros hated me. I wasn’t good enough to win but I was good enough that it took them all night to clean me out. That made for a far less productive seat.

  2. Posted July 7, 2012 at 6:45 am | Permalink

    I’m coming back and reading through your blog Jim. This is such a great post. I really like the clipart, complete with watermark, of the “cute receptionist.”

    • Posted August 15, 2012 at 1:23 pm | Permalink

      Thanks, KO…..

      great to have you over here!

      I liked that pic, too!

  3. VK
    Posted March 15, 2014 at 11:39 pm | Permalink

    Hello Jim,
    I love your articles and agree with most of them. I’m on the fence on this particular one.
    I’m currently following AAII’s model shadow stock portfolio which has worked great for me since I started following it in the past couple of years.
    I’m young and have been investing only a few years in the market and I’ve been seeking the answer to this question – should I invest in individual stocks or index funds.
    AAII’s shadow stock portfolio’s return since inception in 1995 has been 17.9% vs S&P 500′s 9.43% for the same period. It seems to me that their model certainly seems to be working. I would like to know your thoughts as well. Do you still believe it’s better to invest in VTSAX vs just shadowing AAII’s model stock portfolio?

    • jlcollinsnh
      Posted April 10, 2014 at 10:07 am | Permalink

      Hi VK…

      Glad you love what you are finding here and hope you continue to read more.

      This post is really at the core of what I believe and discuss here. It is not just my opinion, but the conclusion of an ever increasing body of research. Even Warren Buffett, perhaps the best stock picker of all time, is on board with the concept of indexing.

      I am unfamiliar with the AAII model you mention, but there are countless investments out there striving to out perform the market. Some do for some periods of time, and they are endlessly creative in presenting their track records in the most favorable light.

      But every prospectus carries this warning: “Past performance is not a guarantee of future results.”

      The are both the truest words in these documents and the most ignored.

      It is easy to look back and find the funds and portfolios that have outperformed in the past. It is impossible to predict which will do so in the future.

      That said, it is great AAII has worked well for you so far and I completely understand the temptation to continue. It just seems so reasonable. It took me years to accept how vanishingly difficult it is to outperform the market and how rare and fleeting those that seem to are.

      For more, check out my story of CGMFX at the end of this post: http://jlcollinsnh.com/2011/06/14/what-we-own-and-why-we-own-it/

      Good luck!

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