Full of Bull – Stephen T. McClellan (2010) – Executive Summary & Key Messages

Wall Street Analysts are bad at stock picking: Analysis of all sell and buy recommendations in 2003 showed that the portfolio with negatively viewed stocks gained 53.5% (over two years), more than 75 percentage points better than the market.  Investing, contrary to the Analyst’s opinions, brings the better returns.

The Street normally interprets Hold opinions negatively, and so should individual investors.

Wall Street is having a strong favourable bias.  Ratio is about 2/1 in large firms, and 7/1 in smaller firms.

When analysts finally go to the Sell opinion, the stock likely already had hit rock bottom.  Their opinion changes are often difficult to get approved internally.  Inertia is much more “convenient” for them.

After most of the ratings have been downgraded, it might be a good buying entry point for a patient investor.  After most analysts are pessimistic, the share price has only one way to go—back up.

On the other hand, investors should sell when analysts overstress their enthusiasm.

High analysts’ coverage correlates to higher stock premiums.  Lower coverage correlates to stock price discounts of those usually smaller caps—with a better prospect of undiscovered value.  They have a Big Company Bias!  Small caps are neglected, although they outdistance the big caps by a factor of 100 times from 1926 to the present.

Price objectives/price targets from analysts are just plain fiction.

Analysts miss secular shifts as they are too narrowly concentrated on details and do not heed the bigger picture.

By the time most investors hear or read research views, it is way too late and the big players have already acted.

Analyst research is valuable just for background understanding.

Wall Street disregards Market Strategists and Technical Analysis: If analysts are too bearish for too long, their brokerage firms get antsy and push them out the door.

Street insiders discount any flamboyant opinion upgrades from April to June.  In contrast, rating downgrades are avoided like the plague during this period.  Be prepared for a mini-flurry of catch-up downgrades during late June or in August.  July is the earnings period and it is awkward and risky to lower an opinion.

Hedge Funds make the playing field totally unfair as they do not have to conform to SEC regulations.  They can essentially manipulate stocks to their advantage and their holdings do not have to be reported.

Analysts have to maintain friendly association with executives of the companies that they cover with the effect of biasing their investment opinions.  How can they be neutral?

Selecting the Best Company to invest:

  • Find unique, focused companies leading a new or niche market.
  • Look for specialized and simple businesses with a singular product area as they always outrun the generalists.
  • Seek double-digit growth (but also not above unsustainable 25%) or robust repeatable cash generation.
  • Avoid arrogant or overconfident management.  Be careful of managements that have too many perks (corporate aircrafts, sumptuous HQs).
  • The listing requirements of the NYSE are more rigorous than NASDAQ.
  • Earnings quality and conservative accounting are paramount.
  • Look for stability and consistency.
  • A dramatic acquisition in troubled times is diversionary.  It’s a disguise/cover up of bad numbers.
  • Turnarounds rarely work out.
  • Be cautious of excessive hype and promotion.  Companies with hyperactive publicity campaigns lack substance.

Preserving Capital is the first priority.  Cash does not crash!!

Look for broad themes, rather than trendy ideas.  Sector timing/Sector rotation.

Owning too many stocks is “de-worse-ification”.  There is no way to stay abreast of more than a half dozen names.

Dividend Yield is important: From 1926 to 2006, the total stock market return averaged close to 11% annually, and 41% of this or 4.4% of the gain each year stemmed from dividends.  Studies show a direct positive correlation between dividend payouts and earnings growth.  The higher the payout, the faster the earnings pace.

Do not seek excitement or entertainment from trading.  Be serious and invest.

Avoid Mutual Funds: The cost of safety is boring mediocrity.  Go with Index Funds (or ETFs) that track precisely a given stock market or industry sector and that charge minimal fees.

Pragmatic Investing Practices and Techniques:

  • Do not be in denial.  Take the loss and move on.  It hurts only for a bit, and then you feel liberated.
  • When you have decided, take action.
  • Short-Term trading positions should be contracted to a limited time frame, regardless of whether the idea was a winner or a non-event.  Do not let the stock sit around and clutter up your portfolio.
  • Do not buy or sell in reaction to press articles or media information.  Once it is published, it has already impacted the stock price.  “Buy on rumor, sell on news.”
  • Pay attention to contrary evidence that might prove your decision wrong.  Don’t fall in love with your viewpoint.
  • Hedge Fund positions are a source of credible investment ideas.  They do not suffer from conflicting influences or biases as in brokerage firms.  Their stock selections are more impartial.

Investment strategies to survive in a Bear Market:

  • It’s a serious bear market when stocks have dropped by 25% over a six-to-nine-month period.
  • Every time SPY PEs surged above 20x there followed a sharp decline (Feb 2013 = 17.2x; Oct 2014 19.5x !!!).
  • Get beared-up, bear-market resistant, or at least bear-market retardant.
  • It is more risky to get back in too early than to miss the first portion of the recovery.  There will be ample time to wade back into a gathering bull market.  “It is the second mouse that gets the cheese.”

Earnings Quality: Many start-up companies are not able to predict their business within a narrow range of each quarter; eg., Google.  A management team distracted by a series of short-term targets is as pointless as a dieter stepping on a scale every half hour.

Earnings Estimates often move in reaction to news, not in anticipation of it.

Stock Buybacks and Dilutive Stock Options are a turnoff.  They usually occur when profits have stalled or when the stock price has languished.  They are usually a waste of money.  Less than 25% of the 423 S&P 500 firms that repurchased shares, from 2006 to mid-2007, had their stocks outperform the index.  That 75% would have been better off by doing nothing.

Due to all the systemic flaws of the current “Street Procedures” individual investors will just have to work around the Street, learn its ways, exploit it, and in the end be responsible for their own investment decisions.

Only use Street’s information and its research content, not its conclusions or recommendations!  Research Reports are good for background information, but they are not actionable.

As Warren Buffet said: “Never ask the barber if you need a haircut.”

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