Think of stock analysis like a trial…
Mr. Market is on one side. He argues for following trends reflected in stock charts. He also supports working with technical-analysis indicators and sentiment-related data.
Mr. Contrarian opposes Mr. Market. “Be smarter,” he says. “Buy when others are fearful. Sell when they’re greedy.”
But as I explained yesterday, the reality is that Mr. Market is powerful. He collects a lot of information. And he’s able to analyze it all much better these days than in the past.
So over the long run, it’s best to start with the presumption that Mr. Market is right.
However, we’ll turn things around today…
Mr. Market sometimes gets sloppy with his analysis. He isn’t right all the time. And when he’s wrong, Mr. Contrarian can jump in with the perfect objection…
Consider building an argument around valuation. Mr. Market occasionally struggles in this area…
Now, he knows about valuation ratios like price to earnings, price to sales, and price to book value. But from time to time, his agenda may work against him…
You see, Mr. Market is what he is because of professional investors. After all, institutional investors account for about 80% of the market.
These pros have a lot of skill. But they’re burdened by obligations to clients. And those burdens can push Mr. Market into some odd positions…
For example, pros with lagging returns risk losing their clients to rivals. They can’t risk underperforming their peers.
Put simply, the pros have to perform well – or else.
The pros’ attempts to please their clients are a real market force. And importantly, they can distort the “plain as day” data Mr. Market thinks he’s seeing.
In an ideal world, clients would appreciate excellent valuation analysis. But in the real world, clients envy others who continue to ride hot, overpriced stocks higher and higher.
It’s the same story with undervaluation. Many folks simply aren’t patient enough to wait for cold-but-cheap stocks to finally shine. It’s human nature to want instant gratification.
And since value investing often requires patience, many pros avoid it.
So Mr. Contrarian has an edge here…
He can act on his valuation convictions. And since he doesn’t need to worry about pleasing and retaining clients, he can afford to be patient.
More often than you think, Mr. Market gets valuation wrong. The pros pile up on a popular trade, hoping to please their clients.
But all that does is distort poor Mr. Market’s view.
On the other hand, Mr. Contrarian wears glasses that help him see through these distortions. And when he can spot one of them… he nearly always beats Mr. Market.
Neither side will likely ever have 100% of the evidence in its favor. It’s about having as much evidence as needed to overcome the initial presumption in favor of the other side.
Either way, it’s about evidence and being able to see it.
You don’t have a gavel or sheriff in the Court of Investor Opinion. But remember, you do have a computer mouse. So use it… Do your own research and make your own ruling.