- Over the last 35 years, investing in the 10% of U.S. stocks analysts were were most pessimistic about would have yielded a staggering 15% a year
- Investing in stocks analysts were most optimistic about would have yielded 3%
The key to making money is to not listen to analysts, researchers have found.
They say the best way to make money is actually to invest in the shares least favored by analysts.
Research by Nicola Gennaioli and team at Bocconi University in Italy found that over the last thirty-five years, investing in the 10% of U.S. stocks analysts were most optimistic about would have yielded on average 3% a year.
Italian researchers found that over the last 35 years, investing in the 10% of U.S. stocks analysts were were most pessimistic about would have yielded a staggering 15% a year.
By contrast, investing in the 10% of stocks analysts were most pessimistic about would have yielded a staggering 15% a year.
‘In a classical example, we tend to think of Irishmen as redheads because red hair is much more frequent among Irishmen than among the rest of the world’, Prof. Gennaioli says.
‘Nevertheless, only 10% of Irishmen are redheads.
‘In our work, we develop models of belief formation that embody this logic and study the implication of this important psychological force in different domains’.
Gennaioli and colleagues shed light on this puzzle with the help of cognitive sciences and, in particular, using Kahneman and Tversky’s concept of representativeness.
Decision makers, according to this view, overweight the representative features of a group or a phenomenon.
These are defined as the features that occur more frequently in that group than in a baseline reference group.
THE GOOGLE PROBLEM THAT BLIGHTS INVESTORS
After observing strong earnings growth – the explanation goes – analysts think that the firm may be the next Google.
‘Googles’ are in fact more frequent among firms experiencing strong growth, which makes them representative.
Experts say that the ‘Google problem’ is a key failing of many analysts, where they believe a company will have a far bigger impact than it actually does
The problem is that ‘Googles’ are very rare in absolute terms.
As a result, expectations become too optimistic, and future performance disappoints.
A model of stock prices in which investor beliefs follow this logic can account both qualitatively and quantitatively for the beliefs of analysts and the dynamics of stock returns.
After observing strong earnings growth – the explanation goes – analysts think that the firm may be the next Google.
‘Googles’ are in fact more frequent among firms experiencing strong growth, which makes them representative.
The problem is that ‘Googles’ are very rare in absolute terms.
As a result, expectations become too optimistic, and future performance disappoints.
A model of stock prices in which investor beliefs follow this logic can account both qualitatively and quantitatively for the beliefs of analysts and the dynamics of stock returns.