What is it about us humans that we can be oblivious to crucial evidence that’s as clear as day? The stock market is a good example. I’m not suggesting that as investors we ignore blatantly obvious evidence of a stock’s likely trajectory. What I’m referring to is more serious. It is that we follow the advice of highly paid independent investment analysts when there’s compelling evidence that many are far from independent, but navigate a complex web of conflicting interests in a private club restricted to the analysts themselves and to the big investment banks and brokers they “advise”. The losers are the other players, especially the smaller investors. The stocks these analysts champion rise because enough people believe their hype. That hype often has little to do with a company’s track record, future plans, senior management, or competition. This problem is widely known, yet most investors don’t seem concerned. It’s possible that many believe that the problem was solved when the US Congress passed the Sarbanes-Oxley reform legislation in 2002. But they’d be wrong. The level of abuses decreased, but the problem is still endemic and more creatively disguised.
A second difficulty with expert analysts is a variation of what I call “The IBM Syndrome” – the decades-old IT adage that says, “You don’t get fired for buying IBM equipment.” An IT director might have saved a company a substantial sum by recommending a more cost-effective alternative manufactured by a less well-known computer company, but few IT managers were willing to take the risk; they followed the herd and recommended IBM. Investment experts suffer from the same herd mentality. Like IT directors, most follow each other, afraid to make the contrarian call and go with their gut feeling. Just look at Apple stock.
The collapse of Apple’s share price since late 2012 was on the cards for at least a year for numerous reasons. I was one of a small number of commentators who raised the red flag early. See my January 2012 blog “Has Apple Reached the Tipping Point?” Yet most experts and investors chose to ignore powerful evidence, and followed each other like lemmings. The stock was trading at $702 on September 19th, 2012. By March 4th 2013, it had tumbled by 40% to $419. Ironically, that is roughly the price it was trading at when I wrote my blog article in January 2012.
Apple’s stock price collapse is a textbook example of a third and less common investing problem: vanity. Apple’s marketing strategy ingeniously exploited the guru-like veneration of Steve Jobs by implying that not only were Apple products ultra-cool, but so were their users. They bought into this vision and saw their devices as strong fashion statements, which told the world that they themselves had a unique sense of style, above average intelligence, and the cash to prove it. Apple exploited this age-old marketing stunt to the full. Yet the results surpassed the company’s wildest dreams because not even Jobs could have guessed that the same psychological factors that caused people to buy iPhones and iPads would induce serious analysts to recommend Apple stock and astute investors to buy it. Yet millions of usually cautious people did just that. They bought first to make a statement and second to make a profit.
A fourth factor that works against ordinary investors is experts’ greed. Even if legislation eliminated all conflict-of-interest issues (which it couldn’t), and analysts and brokers stopped following the herd and left their egos at home, underlying greed is never far away. Despite Gordon Gekko eulogizing the word, greed is not good. Analysts’ recommendations to “buy” as opposed to “sell” stocks are disproportionately weighted in favor of the former because of greed. Brokers’ revenue depends on trading volume, and a “buy” is likely to generate more trading than a “sell” since everyone is a potential buyer, but only stock owners can sell. ( yes you can borrow stock, sell it and go short – a blog post for later)
Not all experts are dishonest, or follow the herd, or are unduly influenced by greed and fashion. Many are meticulous and trustworthy, and provide valuable, accurate advice, though they often struggle to convince clients that they’re not just like the rest. That’s a pity since all investors need unbiased market intelligence, whether they’re in the market for the long haul or a quick profit, and whether they stand to gain from a stock rising or, in the case of short selling, from it falling.
That’s why investors should do their own research, even if they also pay for professional advice. They should critically scrutinize company data from numerous unrelated sources. That data should provide comprehensive information on the company’s key personnel, recent balance sheet figures, innovation record, competition profile and the likely future impact of local, national and global political developments on its business. If Apple investors had coldly examined such data in 2012, most would not have been burnt. Yet they chose to ignore strong warning signs – two in particular. First, the company’s chief executive and visionary leader, Steve Jobs, had recently died. Second, a growing number of formidable innovative competitors – Samsung in particular – were eating into Apple’s core markets of smartphones and tablet computers at an alarming rate. In the last six months, a third less obvious but potentially lethal warning sign appeared on the horizon: A growing number of people were starting to see Apple’s products as being for an older market segment. Samsung had shrewdly nurtured that image for a few years, and last year highlighted it in a clever TV advert for the Galaxy S3. It shows a long line of people queuing for what is obviously a new iPhone, (though the advert doesn’t explicitly say so). Unlike all the others, one young guy in the queue is using a Galaxy S3, and the guy beside him asks, “…guess the Galaxy S3 just didn’t work out for you?” “No, I love the G S3,” the first one says, “I’m just holding this spot for someone.” When the “someone” arrives it turns out to be two people: his parents. Ouch!
On March 4th, investment guru Jeff Gundlach (who like me had predicted the collapse of Apple stock a year ago) was quoted by influential Business Insider website as saying that the collapse of Apple’s stock price “effectively debunks ‘efficient market’ theories.” The efficient market theory hypothesizes that the market always prices a stock correctly because it accounts for all relevant information about the stock. Apple proves how wrong and dangerous that theory is.
Apple’s stock collapse teaches us many valuable lessons, but four in particular. The first is to treat investing as if we’re lending money – in a way, we are; second, to ignore our egos and fashion trends, and dispassionately examine the market and the company’s fundamentals. The third lesson is to follow the advice of experts only if it makes sense to us, and fourth, to invest no more than we can comfortably afford to lose. Only when we’ve taken those four lessons to heart and done our homework, can we make an informed and independent decision about any potential stock investment. Only then should we consider reaching for the checkbook.
P.S. After many months of consideration I have locked in on my next stock destined to crater. It currently has a 19B market cap and trades around $175. My blog will be out on it within 2 weeks. Stay tuned…
Chart on AAPL