Part two is understanding the advice. A large part of the problem is that many aspects of the advice are unsaid. For example, with a “buy” recommendation:
- What time horizon does this recommendation require?
- How likely is it that this investment will succeed?
- What risk factors could cause the investment to fail?
- How will this advice get updated?
- Have prior investors benefited from this advice?
- What is the benchmark for the advice?
Time horizon is important, even if it were handled approximately, e.g, “six months to two years.” Should you buy for the earnings release and sell thereafter, or is this a company going through a multi-year shift?
The likelihood of success is subjective, but still important. It helps if analysts/touts would clarify how certain they are of success, st least in vague terms.
Listing the risk factors is important. Analysts do less of this than do companies in their prospectuses/10Ks. These are important, and it would be valuable for analysts to see if there are any risk factors not listed, or emphasize the importance of key risk factors.
Knowing how frequently the advice will be updated aids the investors — it helps them understand how much help they will get, or whether after the recommendation, they are on their own.
It helps to know whether the adviser has any real talent or not. Does he just opine, or is his own money on the line? Has he succeeded in the past?
Finally, the benchmark is of utmost importance. Buy! Why, what will it do better than? Is it a relatively good stock? Is it a relatively good stock in its industry? Is it a relatively good bond? Is it just going to do better than cash? You need to understand the comparison that the analyst is making in order to say the stock is a buy.
More in Part III
And finally my fave question – “How does this company stack up against its 2 strongest peers?”
This is something we did in the home school investment club with our kids and I do now for anything seriously considered. Take the co. under consideration and bump it against the 2 strongest peers we can find. Often peers are from the same sector, but sometime we use other attributes to define a set of peers (perhaps paying a solid dividend). Sometimes we find that a strong peer is a better buy.
Yes often times it is a close call and occasionally I will buy a half allocation of 2 peers.
That’s a good question, a keeper.
In general I think the track record thing is hugely under-emphasized. If 65 of your last 100 calls beat their beta component for a 5% overall over-perform, I want to know. And if 60 of your last 100 were losers for a 8% under-perform, I need to know that too.
Obviously the track record needs to be long enough that I can be confident it’s not just survivor bias too.