Wednesday, 20 June 2018

Picking the best stocks is like picking out the prettiest faces in a beauty contest.

Keynes wrote:  "Day to day fluctuations in the profits of existing investments, which are obviously of an ephemeral and non-significant character, tend to have an altogether excessive, and even an absurd, influence on the market."

Keynes was also sceptical that professional money managers would serve the role of the "smart money" that Efficient Market Hypothesis defenders rely upon to keep markets efficient.  Rather, he thought that the pros were more likely to ride a wave of irrational exuberance than to fight it.  One reason is that it is risky to be a contrarian.  "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."

Keynes's beauty contest analogy

This is still an apt description of what money managers try to do.

Many investors call themselves "value managers," meaning they try to buy stocks that are cheap.

Others call themselves "growth managers," meaning they try to buy stocks that will grow quickly.

But of course no one is seeking to buy stocks that are expensive, or stocks of companies that will shrink.

So what are all these managers really trying to do?

They are trying to buy stocks that will go up in value - or , in other words, stocks that they think OTHER investors will LATER decide should be worth more. 

And these other investors, in turn, are making their own bets on others' FUTURE valuations.

Buying a stock that the market does not fully appreciate today is fine, as long as the rest of the market comes around to your point of view sooner than later!

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