Value Investing and Contrarian Thinking

Value investing by its very nature is contrarian. 

Out-of-favor securities may be undervalued; popular securities almost never are. 

What the herd is buying is, by definition, in favor. 

Securities in favor have already been bid up in price on the basis of optimistic expectations and are unlikely to represent good value that has been overlooked. 

Where may value exist?

If value is not likely to exist in what the herd is buying, where may it exist? 

In what they are 

• selling, 
• unaware of, or 
• ignoring. 

When the herd is selling a security, the market price may fall well beyond reason. 

Ignored, obscure, or newly created securities may similarly be or become undervalued. 

Contrarians are almost always initially wrong

Investors may find it difficult to act as contrarians for they can never be certain whether or when they will be proven correct. 

Since they are acting against the crowd, contrarians are almost always initially wrong and likely for a time to suffer paper losses. 

By contrast, members of the herd are nearly always right for a period. 

Not only are contrarians initially wrong, they may be wrong more often and for longer periods than others because market trends can continue long past any limits warranted by underlying value. 

When contrary opinion can be put to use.

Holding a contrary opinion is not always useful to investors, however. 

1.  When widely held opinions have no influence on the issue at hand, nothing is gained by swimming against the tide. 

• It is always the consensus that the sun will rise tomorrow, but this view does not influence the outcome. 

2.  By contrast, when majority opinion does affect the outcome or the odds, contrary opinion can be put to use. 

• When the herd rushes into home health-care stocks, bidding up prices and thereby lowering available returns, the majority has altered the risk/ reward ratio, allowing contrarians to bet against the crowd with the odds skewed in their favor. 
• When investors in 1983 either ignored or panned the stock of Nabisco, causing it to trade at a discount to other food companies, the risk/reward ratio became more favorable, creating a buying opportunity for contrarians. 

Maybank among top losers as KLCI falls nearly 15pts

Tuesday August 20, 2013 

KUALA LUMPUR: Fund selling of key bank stocks including Maybank and CIMB weighed on the market sentiment on Tuesday, pushing the 30-stock FBM KLCI down nearly 15 points.

At 10.51am, the KLCI was down 14.76 points to 1,763.60. Turnover was 983.32 million shares valued at RM804.39mil. Losers thrashed gainers 614 to 71 while 219 counters were unchanged.

At Bursa Malaysia, Maybank fell 34 sen to RM10.10 with 15.45 million shares done, HL Bank lost 28 sen to RM13.90 and CIMB 21 sen lower at RM7.69.

Bloomberg reported Asian stocks fell for a fourth day, with the regional benchmark equities gauge trading near a two- week low, as metals prices declined for the first time in five days and profit at QBE Insurance Group Ltd slumped.

The wire report said speculation that the Federal Reserve will curb bond buying spurred investors to sell risk assets across Asia and emerging markets. The Federal Open Market Committee's July meeting minutes are scheduled to be released on Wednesday.

http://www.thestar.com.my/Business/Business-News/2013/08/20/Maybank-among-top-losers-as-KLCI-falls-nearly-15pts.aspx

The divergent styles of value investing

1.  Some of the value investors invest only in superior businesses that they intend to own for decades, if not forever.

2.  Others, are looking for damaged goods that have been thrown on a rubbish heap, even though the assets or businesses are still worth something.

3.  Some investors run portfolios with six or eight stocks, others will own more than a hundred companies at any one time.

4.  Some of them buy bonds of  companies headed for or already in bankruptcy, thinking that either the bonds will be redeemed for more than their cost or that they will end up owning equity in a reorganized company as it emerges from bankruptcy.

5.  Some seek to avoid the crowd by concentrating on small and tiny companies; others prefer the stability and predictability of established firms with good businesses.

6.  Some try to buy shares in companies that they feel will command a premium from an industrial purchaser who wants to own the whole firm.

7.  Others play that role themselves and purchase the entire company.


There are many dimensions along which value investors differ from one another in how they select their companies: size, quality, growth prospects, asset backing, location (domestic only or more international), and so on.  They also differ on how they assemble their portfolios:  broadly diversified, industry-weighted to take advantage of a circle of  competence, moderately concentrated, or tightly focused.

All put the most emphasis on the "quality of company" dimension.  The quality dimension entails preferences concerning valuation approaches (assets, earnings, growth), the breadth of the portfolio (better companies generally mean more concentration), and the expected time for holding the shares (for the deeply discounted stock, until they recover; for the great companies, forever).

Direct and active investing is a dangerous game, not a trick one can do casually at home.  The easy availability of real-time security prices and inexpensive trading has convinced many otherwise sensible people that investing on their own will provide both enjoyment and profit.

When Mr. Market creates opportunities for value investors by overreacting to information or otherwise plunging to an extreme, most participants are part of that herd, not the few standing to the side.  To recall a piece of wisdom Warren Buffett frequently cites, if you have been in the poker game for thirty minutes and still don't know who the patsy is, you can be pretty certain the patsy is you.

Ref:  Bruce Greenwald

Cognitive Biases That Cause Bad Investment Decisions

Henry Stimpson

Published: Tuesday, November 29th 2011

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When it comes to investing, you might think your emotions don’t play a role, but they do without you even realizing it. Everyone has emotional and cognitive biases that shape their choices, and only by spotting them can you overcome them so they don’t cause bad investment decisions, according to Ben Sullivan, a certified financial planner at Palisades Hudson Financial Group.
Sullivan recalls a number of clients who have made mistakes in the past. A middle-aged banker had more than half of his $500,000 portfolio in a few bank stocks. Another prospective client sold his business to a big consumer-goods company had almost all his money — many millions — in that company’s stock. An employee believed his 401(k) plan was diversified because he owned four funds — all large-cap stock funds.
“Investor mistakes have predictable patterns,” says Sullivan. “Our pervasive emotional and cognitive biases often lead to poor decisions.”

Overconfidence
It’s easy to overestimate your own abilities in picking stocks while underestimating risks. Even professional money managers struggle to beat index funds. The casual investor has little chance, Sullivan says.
“It’s almost impossible to have a day job and moonlight as manager of your individual-stocks portfolio,” he says. “Overconfidence frequently leaves investors with their eggs in far too few baskets, with those baskets dangerously close to one another.”

Self-attribution
This is a cognitive error leading to overconfidence. Someone who bought both Pets.com and Apple in 1999 might dismiss his Pets.com loss (it went bankrupt) because the market tanked but believe he’s an investment whiz because he bought Apple.

Familiarity
Investing in what you “know best” can be a siren song leading investors astray from a prudently diversified portfolio. That was the case with all three investors mentioned above. They were familiar with banks, consumer goods and large-cap U.S. stocks respectively, Sullivan says, and unwisely put all their eggs in that familiar basket.

Anchoring and loss aversion

Investors may become “anchored” to the original purchase price. Someone who paid $1 million for his home in 2007 may insist that what he paid is the home’s true value, even though it’s really worth $700,000 now. The same holds for securities.
“Only the future potential risk and return of an investment matter,” Sullivan says.
Inability to sell a bad investment and take a loss causes investors to lose more money as the hoped-for recovery never happens.
“You’ll also miss the opportunity to capture tax benefits by selling and taking a capital loss,” he adds.


Herd fever
When the market is hot and high, the media and everyone else say buy. When prices are low — remember March 2009 — everyone says sell. Following the herd leads investors to come late to the party so that they’re buying at the top and selling at the bottom. Following the herd is a powerful emotion.
Today, Sullivan says, the herd is buying gold and U.S. Treasuries.

Recency
According to a study by DALBAR Inc., the average investor’s returns lagged those of the S&P 500 index by 6.5% per year for the 20 years prior to 2008 largely because of recency bias. People invested in last year’s hot funds, which often turn sour next year, instead of taking a steady course, he says.
(Ed: Read about how the recency effect has been influencing the housing market.)

Counteracting your biases

Having a written plan is the key, Sullivan says.
“Create a plan and stick to it,” he says.
Hewing to a written long-term investment policy prevents you from making haphazard decisions about your portfolios during times of economic stress or euphoria. Selecting the appropriate asset allocation will help you weather turbulent markets.
All investors should invest assets they will need to withdraw from their portfolios within five years in short-term liquid investments. Combining an appropriate asset with a short-term reserve gives investors more confidence to stick to their long-term plans, he says.
If you can’t control your emotions — or don’t have the time or skill to manage your investments — consider hiring a fee-only financial adviser, Sullivan says. An adviser can provide moral support and coaching, which will boost your confidence in your long-term plan and also prevent you from making a bad, emotionally driven decision.
“We all bring our natural biases into the investment process,” Sullivan says. “Though we cannot eliminate these biases, we can recognize them and respond in ways that help us avoid destructive and self-defeating behavior.”

http://www.physiciansmoneydigest.com/personal-finance/Cognitive-Biases-That-Cause-Bad-Investment-Decisions

Does crowd mentality influence your investment?

The BSE Sensex has multiplied six-seven times over the last decade. And many stocks have sky-rocketed. Some investors have made money. Others have lost money. And most people continue to lose. Strikingly, most people also do what most other people do. Isn't that quite a coincidence? 

In our previous article on crowd mentality, we had emphasised the need to keep away from crowds and to stay focused on company fundamentals. Now let us understand some dynamics of this phenomenon called 'crowd'. We have all had our share of experiences at 'becoming a crowd'. Let's recount some. 

Situation/ Activity	Our response in a crowd
Watching a cricket match in a jam packed stadium	We end up yelling and cheering more than we would otherwise if watching alone on TV.
In a professional company meeting	We're prone to agreeing more often than not.
In Bombay local trains	Need we say anything?
The 2007 bull run. The 2008 crash	Remember???

Let's look back at these common experiences with a different perspective. Of all, one thing is quite clear: 

Being part of a crowd causes people to behave differently from the way that they would in isolation. 

Crowds introduce a very overwhelming emotional and often irrational element to decision-making: making an individual equate his own needs with those of the crowd. This is particularly noticeable in financial markets. At peaks and troughs of the stock market, for example, very few people will be concentrating on the fundamental economic influences. The vast majority will be concerned with only the recent short-term movements in prices themselves. Consequently, this majority will inevitably be on the wrong foot when a price reversal occurs. 

People who have spent a decent amount of time investing in stocks must have often felt a two-way pull on their decisions. Their 'personal' approach may suggest one course of action. On the other hand, the lure of the 'herd instinct' may be pulling entirely in the opposite direction. This is true even for a lot of seasoned professionals. The reason for this two-way pull lies in these two primary tendencies- 

Self-assertive tendency: the ability to behave in a self-determined way. 

Integrative tendency: the willingness to belong to crowds. 

What we ultimately do depends on which of these two tendencies stands prominently in us. 

A crowd is something other than the sum of its parts 

A crowd is a psychological phenomenon. Its formation does not really require the physical presence of its members. All that is needed is a common cause. The most striking peculiarity of a crowd in a financial market is this: 

The individuals composing a crowd may be very different from each other. They may differ in their lifestyles, their character, or their intelligence. But the fact that they have been transformed into a crowd puts them in possession of a sort of collective mind. And the way they feel, think and act gets altered drastically. 

Doesn't this remind you of chemistry lessons? Two or more different elements combining together. Then transforming into a compound whose characteristics are quite distinct from that of its components. Ditto for investors! Successful investment, therefore, depends on an individual's ability to stand aside from the crowd's influence.




Equimaster

Herd mentality costs investors dear

Herd mentality costs investors dear
Thousands of investors have missed out on the recent FTSE gains because they shunned equities.

Investors that follow the herd lose out 

By Paul Farrow, Personal finance editor 6:01AM GMT 13 Nov 2010

Comments

Investors' habit of following the herd has cost them hundreds of millions of pounds in lost returns as the FTSE 100 continues to climb.

The blue chip index has returned more than 50pc over the past 20 months. Yet hundreds of thousands of investors will have missed out on those gains because they were busily withdrawing money from equity funds as the market fell.

Go back to the start of 2009 and investor confidence was at an all-time low after the banking crisis. The FTSE 100 had fallen sharply and investors sought sanctuary in bond funds and absolute return funds (which aim to deliver positive returns in falling markets). During the first three months of 2009 net sales of corporate bonds were £4bn, compared with just £200m in equities, official figures reveal.

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The timing of their run to safety couldn't have been worse. Since January 2009 the FTSE 100 has risen by 52pc – by comparison, the average corporate bond fund has returned 28pc, the average absolute return fund 9pc and the average cautious managed fund (another big seller) 23pc. The bestselling absolute return fund, BlackRock Absolute Alpha, is up by just 4pc – it is not designed to deliver bumper returns in a bull run.

Alan Steel of Alan Steel Asset Management asked: "Why is it the herd always piles into the wrong sector or investment at the wrong time?" One reason for a herd approach is that investors follow performance and this frequently sees them buy at the top of the market and sell at the bottom.

In 2000, for example, investors waded into technology funds when they should have been avoiding the sector. Those who bought at the peak soon saw the value of funds more than halve.

The 2006 commercial property phenomenon was another classic example. Many investors bought the funds as valuations reached unsustainable heights; the ensuing credit crisis triggered sharp falls in fund values.

Mr Steel said contrarian investors were often mocked, even though they can be proved right. "In February 2009 I suggested that stock markets were likely to rise imminently. I received comments from people who, anonymously, suggested I should be locked up or burned at the stake," he said.

"As doomsters on the telly continue the constant bad news with predictions that never come true, such as the double dip that's supposed to happen or the British economy that's supposed to collapse, I think it is better to share what's actually happened since the terrible days early in 2009. And it's good news."

Mr Steel is feeling smug with some justification, as the funds he recommended have soared. Neptune Russia and Greater Russia are up by 150pc, First State's Global Emerging Market fund has risen by 140pc, J P Morgan Natural Resources is up by 120pc and M & G Global Basics by 80pc, he says.

So what now? Investors will be chewing the cud, wondering whether they are at risk of buying shares at the wrong time again, given the FTSE 100's lofty rise to a 28-month high.

Mr Steel said he was expecting a correction, but insisted that investors should not avoid buying shares for fear of a setback. "We've been hoping for a little correction just to get a bit of common sense back into expectations for equities and it may still happen over the next couple of weeks. But we believe this is a time to embrace equities, not only in emerging markets and the Far East but in other places including Britain and the US," he said.

John Chatfeild-Roberts of Jupiter said the easy money made off the back of bombed-out shares had been made. But he believes that, as long as investors are selective about the shares and funds they buy, equities are still the asset of choice. UK funds he owns are Fidelity Special Situations, Invesco Perpetual Income, M & G Recovery and Jupiter Special Situations. "Government bonds are unlikely to provide a real return in the medium term, but many of the blue chips have not taken part in the rally and remain cheap," he said.

With clouds still hovering over the British economy, FTSE stocks that derive a significant chunk of their earnings from overseas have also been getting attention from fund managers.

"We are keen on UK companies with overseas exposure and the ability to raise profit margins from current levels," said Colin McLean at SVM. "British industrial companies such as IMI and Croda are still underrated relative to international peers, and could attract bids. Other leading global brands listed in the UK include British Airways and Burberry."

He added: "The risks in the stock market are in businesses more exposed to the British economy; consumer sectors and banks. Investors should focus on assets that have some protection against a weak pound and a sluggish UK economy."

Robert Burdett of Thames River agreed that the easy money in the UK had been made, but he still believes that shares offer good value and are cheap relative to most other asset classes. "Over a five-year-plus view I would not hesitate in putting equities first above bonds, property and other major assets," he said. Mr Burdett's favoured UK funds include Standard Life UK Opportunities, JOHCM UK Growth and Artemis UK Special Situations.

Many advisers reckon that UK equity income funds, which have not fared as well in the past three years, are also worth considering. Dividends are making a comeback after a disastrous two years and could be a useful contrarian bet.

Adrian Lowcock of Bestinvest said: "With stock markets reaching recent highs, a long-term approach to investing would be through companies with good cash flow, many of which pay good dividends. This is a long-term investment strategy and will provide some short-term protection should markets retreat.

"We recommend the Artemis Income fund in this respect."


http://www.telegraph.co.uk/finance/personalfinance/investing/shares-and-stock-tips/8129968/Herd-mentality-costs-investors-dear.html

Classic example of herd mentality: Buying into small and micro-cap companies just because they have rallied on the bourses.

Ignore the herd, be your own master



Nikhil Walavalkar, ET Bureau

A teacher once asked a student, “If there are 10 sheep in a field and one escapes through a hole in the fence, how many are left?” Student answers, “None.” When the teacher berated the student for his poor maths, the student replied, “I know my maths, but you do not know about sheep.”

Some investors find it difficult to invest gainfully in equities because of behavioural issues. Here are some of the factors that investors should be careful about while investing in equities.

Herd mentality



Herd mentality means the sheep-like tendency to mimic others. “ Herd mentality can adversely impact an individual. When there is a scarcity of resources, it can be fatal,” says Om Ahuja, head – wealth management & strategy, Emkay Global Financial Services.

Most of the time, it leads to bad investment decisions as an individual ends up buying something unsuitable for his needs. Buying into small and micro-cap companies just because they have rallied on the bourses is a classic example of herd mentality. In most cases, followers fail to notice a change in the trend and incur losses. Unfortunately, blind followers return when they spot a herd to follow.

One can look at this from another angle. People tend to purchase a financial product when they get a call from a distributor who also tells that your best friend or neighbour has also bought it.

Anchoring



We tend to value our assets using certain reference points which may have no relevance to the present market condition. For instance, many assume that when a stock hits a 52-week high, it is time to book profits. Since listing, HDFC has hit 52-week highs several times.

Had you sold because the stock has hit a 52-week high, you would have lost heavily on opportunity. “The price point that an investor gets anchored to is the cost price, and if the stock goes down and the investor does not book loss, he aggravates his loss,” says Jayant Pai, vice-president, Parag Parikh Financial Advisory Services.

A similar example of anchoring can be seen in other day-to-day decisions like sales. Buyers may travel an hour to throng a sale offering 50% discount, even if the value of the purchase is a few hundred rupees, but he may ignore a 0.5% discount on something that costs tens of thousands of rupees.

Overweighing what can be counted



Albert Einstein got it right when he remarked, “Not everything that counts can be counted and not everything that can be counted, counts.” Many a time investors come across a stock that seems to be ignored by market forces. Such stocks represent a business with sustained rise in profits, return ratios higher than industry norms and a fantastic looking business model. For years the market has not given the stock its due and it quotes at bizarre valuations.

In heady markets such as the one we are living in, such hidden gems come forth and naive investors fall for them. Barring stray instances, they land on the wrong side. The reasons remain in the not measurable segment of analysis.

Endowment effect



It is the ‘endowment effect’ that blindfolds many investors when the stocks they hold start their downward journey. Individuals believe that the things they own are worth more than their real worth. Investors are no different. The stocks owned by them are seen to be more valuable than their actual worth. Investors find reasons to substantiate why they bought a stock and why they were holding on to a particular stock.

Theme junkies

To a man with a hammer, everything looks like a nail. When investors have only one idea, it can be a very dangerous situation. Especially, if the idea is a borrowed one, it can be fatal. When investors hear themes such as ‘India consumption’, there is a tendency to go for it and scenario starts worsening when investors try to look at ‘consumption’ in each and every stock they come across. Instead of being objective, investors try to rationalise and incur losses in the long term.

Incentive-caused bias



“Never ask a barber whether you need a haircut,” goes the old saying. Some lawyers induce clients to litigate when it is in the clients’ interest to settle and some doctors prescribe high-cost treatment when they could have treated the patients with a cheaper solution. These are classic instances of incentive-caused bias. In financial markets, we come across many such barbers – read intermediaries with vested interests. Sell-side analysts – analysts who recommend stocks to others – are a classic case in point. Typically, a sell-side analyst has more of ‘buy’ recommendations than ‘sell’ recommendations. They are to be watched out more carefully in boom phases.

On the other hand, there are some distributors offering investors products that offer the distributors higher fees or commissions and are not in the best interest of the investors.

http://economictimes.indiatimes.com/quickiearticleshow/6317492.cms

The Sentiment Curve of Investing

The more you know about your psychological biases, the better you can function in the volatile stock market.

Everyone has opinions and psychological biases.  However, people may not know their own biases.

The more you know about your psychological biases, the better you can function in the volatile stock market.

The entire market may be influenced by psychological reasons, not by fundamental reasons alone.

From an investment perspective, the bottom line is that the market will continue to fluctuate and give you solid opportunities every so often.

Value in the long run is determined by fundamentals, while short-term gyrations reflect market participants' psychological weaknesses, such as herding.  

Knowledge is the best antidote to making wrong decisions.

If you are a long-term investor, the rational thing to do is to make decisions based on long-term fundamentals of the business.

Here is a technique to learn more about your buying and selling decision making.

You may separate all the months the market went up from the months the market went down.  Do this from the year 2005 to now, which includes the 2008 severe bear market.

From your CDS account statements, you can find out whether you were a net buyer or a net seller during these various months.

• If you were a net buyer during the months the stock market declined, you are more likely to be a contrarian.  
• But if you were a net buyer when the stock market did well, you may have a herd mentality.

When investing in stocks control your greed and fear

Wednesday May 6, 2009
When investing in stocks control your greed and fear

Personal Investing - A column by Ooi Kok Hwa

We need to know who we are in order to do well in stock market investing

THE recent strong market rally caught many investors by surprise again.

Most investors, including some analysts, predicted earlier that it was just a bear market rally. They have been hoping the market will turn down again. Unfortunately, it has been moving up strong without looking back.

For investors who have not invested during the recent low in March 2009, they are getting very worried as they are not benefitting from the recent rally. They may even wonder whether they should jump in now in order not to miss the boat.

Another group of investors, who have managed to catch some stocks at cheap prices during the previous market low, are also facing the dilemma of whether to lock in their gains now or continue to hold on to their gains. Some even regretted selling their stocks too early last month.

We all know that it is very difficult, in fact impossible, to predict stock market movement. Most investment gurus will refuse to time the market.

Howard Kahn and Cary Cooper published a book titled “Stress in the Dealing Room” in 1993. According to their surveys done on 225 dealers, 73.8% of them suffered from fear of “misreading the market.” Most dealers have the same problem of acquiring and handling information.

We believe that in order to do well in stock investing, we need to know ourselves, especially in controlling our emotion on greed and fear.

Due to information overloading, our emotion is highly influenced by the news that we read. Each time we feel that the market is getting bullish and time to buy stock, the overall market will collapse the moment we enter.

On the other hand, the moment we fear that it will drop further and we have decided to cut losses, we will notice the market will recover after that. Most of the time, the prices of stocks that we sold were at the lowest of the recent fall.

In order to control our greed and fear, we need to ask ourselves whether the market has discounted the news that we have received.

For example, many analysts have been bullish lately, having the opinion that the worst may be over for the market based on the recent economic indicators which showed that the overall economy may have stopped contracting or is on its way to recovery.

Nevertheless, the recent strong market rally would have discounted this bullish news. In fact, we need to ask ourselves whether the current stock prices can be supported by the fundamentals for certain listed companies.

In our experience, in most cases, the moment we feel like buying stocks is the best time to sell them while the moment that we feel like selling them is in fact the best time to buy. We can apply this contrarian theory quite successfully in most periods.

Sometimes, if we are taking in too much contradicting information and, as a result, get confused over the market direction, we feel that the best strategy is to stay away from the market until we have a better and clearer picture of the overall market or the economic situation.

We should not be influenced by other opinions.

There are times that we need to follow our heart. Sometimes, our hearts try to warn us from taking hasty investment decisions. However, we refuse to follow our intuition but instead, choosing to get influenced by others or the information that we read and ending up making mistakes.

In conclusion, we need to maintain our concentration.

We should not be led by the market sentiments regardless whether it is on the way up or crashing down fast. We need to go back to the fundamental of economic situation and the companies’ performance and future prospects.

One way to minimise the feeling of regret is to stagger our purchase and selling. We will only know the peak when the market starts turning downwards and vice versa. Therefore, by staggering, we will have an averaging effect rather than taking a one-time hit, especially if it is at the wrong timing.


Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting

http://biz.thestar.com.my/news/story.asp?file=/2009/5/6/business/3838362&sec=business

A phenomenon called "herding."

Why You Shouldn't Follow Warren Buffett
By Tim Hanson and Brian Richards April 30, 2009 Comments (7)

Have you ever bought a stock because Warren Buffett bought a stock? You know, like Coca-Cola (NYSE: KO) or Wells Fargo (NYSE: WFC)?

If so, you're not alone. In fact, thousands of investors follow Buffett's every move, and that's such a hassle for the Oracle of Omaha that he has actually (unsuccessfully) lobbied the SEC to give him a dispensation from disclosing his stock picks.

Heck, it got so bad that in 1999, Coca-Cola was trading for as much as 40 times earnings -- an unbelievably high number for a steady consumer staple that sells sugar water.

Yet, if you believe Alice Schroeder's account in her Buffett biography The Snowball, Buffett wouldn't sell Coca-Cola even then because "the price of Coca-Cola could plunge as a result."
After all, if folks had mindlessly followed Buffett in, thereby driving up the price, they would just as surely follow him out.

This has a name When investors follow other investors into and out of stocks, or use another investor's decision to buy or sell to justify their own decision to buy or sell, you have a phenomenon called "herding."

While Buffett has been wary of passing along his stock ideas since the 1950s and '60s, it wasn't until 1990 or so that financial research established herding as a prevalent and powerful day-to-day force in the market's gyrations.

And recent research from professors Amil Dasgupta, Andrea Prat, and Michela Verardo of the London School of Economics allows us to quantify how herding affects stock prices over both the short and long terms.

We'll spoil the ending for you: Herding isn't much benefit to anyone.

Survey says ... It turns out that institutional herding around a few supposedly great ideas ultimately leads to overvaluation and underperformance.

Money managers -- in trying to avoid being outdone by their colleagues -- flock to the same sets of stocks. In the words of the professors, "money managers tend to imitate past trades (i.e., herd) due to their reputational concerns, despite the fact that such herding behavior has a first-order impact on the prices of assets that they trade."

It's a broken system that punishes investors who aren't courageous enough to think on their own.

But wait!
Not everyone agrees that herding depresses the returns investors can look forward to. Just look at "Imitation Is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway."

The authors studied Berkshire Hathaway from 1976 to 2006 and found that "a hypothetical portfolio that mimics [Berkshire's] investments at the beginning of the following month after they are publicly disclosed also earns significantly positive abnormal returns of 10.75% over the S&P 500 index." Wow.

So, we should all be poring over Berkshire's 13-F filings and buying what Buffett and team did, right? Not so fast.

Those findings are eye-opening and impressive, but in our view, they don't offer much for prospective investors for two reasons:

Berkshire circa 2009 is much different than the Berkshire of the 1970s, 1980s, and 1990s. For one, Berkshire is huge now and can only trade in mega-liquid, mega-cap stocks. More important, because of this herding behavior and its effect on stocks he likes, Buffett now favors private deals or full acquisitions over common stock purchases.

The Internet has revolutionized stock investing, making more information more readily available -- at a faster pace. In other words, informational advantages are likely lessened in the digital era.

It's this latter point that got us to thinking about one of our favorite Web resources, GuruFocus.
What now? GuruFocus is a website that tracks "the buys, sells, and insights" of the world's "investment gurus." This is a list that includes long-term outperformers like Warren Buffett, Wally Weitz, and Seth Klarman.

It's a neat website that sends out neat monthly emails, but we waver on this question: Is it a truly valuable service, or is it merely an interesting service?

After all, you shouldn't be buying or selling stocks because other investors are, and doing so may give you a false sense of security about your decision. As Ben Graham once said, "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right." And that's true even if it's a really smart crowd.

So, what are the current "Consensus Picks of Gurus" (i.e., the stocks the most gurus are buying)? The list includes MasterCard (NYSE: MA), Walgreens (NYSE: WAG), Best Buy (NYSE: BBY), Sun Microsystems (Nasdaq: JAVA), and Canadian Natural Resources (NYSE: CNQ) -- a nice list of businesses, to be sure.

But are these sure winners over the next year, or five, or 10? No.

Who knows why these gurus bought them, or when or why they'll sell them? Was it macro opportunities/concerns? Bottom-up fundamental insights? Something they saw during a meeting with management? Are they selling because of investor redemptions?

Heck, it may be that Ron Muhlenkamp bought MasterCard because he saw that Steve Mandel bought it, or that John Hussman got Best Buy because he figured George Soros knew something.
Again, who knows? The point is: Don't buy stocks because others are buying the same stocks. Don't simply follow Warren Buffett's publicly disclosed stock trades -- following the Oracle's moves, herd-like, is likely to lead you down an unprofitable road.

If you want to profit from Buffett's brain, you have two choices.
Buy shares of Berkshire Hathaway.
Study Buffett's shareholder letters, magazine articles, and body of work, and apply those lessons to your investing.

Both are good courses of action
While buying a share or two of Berkshire is a prudent course of action (Tim added to his position just a few months ago), it is worth noting that Berkshire today is very different from the more nimble version that bought shares in tiny companies such as Blue Chip Stamps, Associated Retail Stores, and Illinois National Bank.

Back then, Buffett was able to focus on good businesses at great prices regardless of size, industry, or geography -- and thus got some great deals on the very small-cap end of the spectrum.

That's what we do each and every day at Motley Fool Global Gains. As co-advisor of Global Gains (Tim) and a contributing author to the international investing chapter of our most recent book (Brian), we believe the good businesses at great prices are the small and foreign companies that American investors largely don't think are worth their time.



Already subscribed to Global Gains? Log in at the top of this page.
Tim Hanson owns shares of Berkshire Hathaway. Brian Richards does not own shares of any companies mentioned. Best Buy and Berkshire are Motley Fool Stock Advisor and Motley Fool Inside Value recommendations. Coca-Cola is an Inside Value selection. The Motley Fool owns shares of Berkshire Hathaway and Best Buy and would like you to meet its disclosure policy.

http://www.fool.com/investing/international/2009/04/30/why-you-shouldnt-follow-warren-buffett.aspx

Behavioural Finance

Behavioral Finance

By Albert Phung

Whether it's mental accounting, irrelevant anchoring or just following the herd, chances are we've all been guilty of at least some of the biases and irrational behavior highlighted in this tutorial. Now that you can identify some of the biases, it's time to apply that knowledge to your own investing and if need be take corrective action. Hopefully, your future financial decisions will be a bit more rational and lot more lucrative as well.

Here is a summary:

• Conventional finance is based on the theories which describe people for the most part behave logically and rationally. People started to question this point of view as there have been anomalies, which are events that conventional finance has a difficult time in explaining.
  
• Three of the biggest contributors to the field are psychologists, Drs. Daniel Kahneman and Amos Tversky, and economist, Richard Thaler.
  
• The concept of anchoring draws upon the tendency for us to attach or "anchor" our thoughts around a reference point despite the fact that it may not have any logical relevance to the decision at hand.
  
• Mental accounting refers to the tendency for people to divide their money into separate accounts based on criteria like the source and intent for the money. Furthermore, the importance of the funds in each account also varies depending upon the money's source and intent.
  
• Seeing is not necessarily believing as we also have confirmation and hindsight biases. Confirmation bias refers to how people tend to more attentive towards new information that confirms their own preconceived options about a subject. The hindsight bias represents how people believe that after the fact, the occurrence of an event was completely obvious.
  
• The gambler's fallacy refers to an incorrect interpretation of statistics where someone believes that the occurrence of a random independent event would somehow cause another random independent event less likely to happen.
  
• Herd behavior represents the preference for individuals to mimic the behaviors or actions of a larger sized group.
  
• Overconfidence represents the tendency for an investor to overestimate his or her ability in performing some action/task.
  
• Overreaction occurs when one reacts to a piece of news in a way that is greater than actual impact of the news.
  
• Prospect theory refers to an idea created by Drs. Kahneman and Tversky that essentially determined that people do not encode equal levels of joy and pain to the same effect. The average individuals tend to be more loss sensitive (in the sense that a he/she will feel more pain in receiving a loss compared to the amount of joy felt from receiving an equal amount of gain).
  

Table of Contents
1) Behavioral Finance: Introduction
2) Behavioral Finance: Background
3) Behavioral Finance: Anomalies
4) Behavioral Finance: Key Concepts - Anchoring
5) Behavioral Finance: Key Concepts - Mental Accounting
6) Behavioral Finance: Key Concepts - Confirmation and Hindsight Bias
7) Behavioral Finance: Key Concepts - Gambler's Fallacy
8) Behavioral Finance: Key Concepts - Herd Behavior
9) Behavioral Finance: Key Concepts - Overconfidence
10) Behavioral Finance: Key Concepts - Overreaction and Availability Bias
11) Behavioral Finance: Key Concepts - Prospect Theory
12) Behavioral Finance: Conclusion