Stock tips are for patsies – are you a patsy?

Overview

“Mr Market is there to serve you, not to guide you,” wrote Warren Buffett in his letter to Berkshire Hathaway’s shareholders in 1987. “If he (is) ... in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand ... Mr Market, you don’t belong in the game. As they say in poker, ‘If you’ve been in the game 30 minutes and you don’t know who the patsy is, you're the patsy’” (italics in the original).

In this article I analyse the tips from amateurs (approximately 13,000 Livewire’s readers), review dozens of analyses extending over more than a century of tips from thousands of professionals – and demonstrate that tipsters and their followers exemplify Mr Market’s exuberance. The lesson is stark: tips might amaze or amuse you; but unless you do your own thorough due diligence you should never heed them.

Nonetheless, conservative contrarian investors like Leithner & Company bear in mind the excesses of tipsters’ emotions. We’ll see that tipsters are overoptimistic; moreover, in order to promote and protect their own popularity they pander to the consensus by tipping popular stocks. These attributes reliably produce underperformance and losses (see in particular Why you’re probably overconfident – and what you can do about it, 14 February 2022). It thus bears repetition: you must either ignore or take advantage of tipsters’ bullishness; you’ll harm your financial well-being if you adopt it.

In short, if you don’t understand stock tips – like lottery tickets, they tacitly overpromise but usually under-deliver – you shouldn’t be investing. Specifically, if you heed them then you're the patsy.

What Is a “Tip”?

“Tipping,” says Investopedia, “is the act of providing material non-public information about a publicly traded company or a security to a person who is not authorized to have the information with the intent to gain some sort of benefit. As long as the information is accurate, tipping can produce huge profits for an investor who acts on it when performing a securities transaction. In most cases, it also leads to unfair gains for the tipper because of pre-arranged agreements to share the trading profits. Tipping is closely related to insider trading.”

This article DOESN’T use words like “tip,” “tipster” and “tipping” as Investopedia does. Stock tips, in the sense that I conceive them, are the financial market version of junk food. They can be habit-forming and certainly don’t bolster your financial health; crucially, however, I’m neither overtly contending nor tacitly implying that any tipster on Livewire spreads inside information or is in any way doing anything illegal.

Instead, I use these words as my dictionary defines them: to tip is “to predict as likely to win or achieve something.”

Specifically, by my conception a stock tip is an idle (that is, empirically flimsy or logically baseless) assertion that a stock will in the short term outperform a market index. It offers the allure of immediate gratification to those who overweight current information, i.e., whose attention span is short.

In The #1 stock picks for 2021 (4 January 2021), for example, Livewire “invited some of the country’s finest stock-pickers to put on their tipping caps and pitch which companies they believe will soar to fresh highs over the next 12 months.”

The problem is two-fold. First, a pitch (which is the form that most tips take) is a far cry from – indeed, it’s the antithesis of – thorough analysis.

A pitch is a very brief, superficial and upbeat story, i.e., a gaggle of soft words which distracts attention from its absence of convincing hard numbers (in the form, for example, of audited financial statements). Investing in reaction to a “pitch” is the exact opposite of due diligence.

Second, stocks’ prices generally fluctuate randomly over periods of 12 months or more (see, for example, Do earnings drive stocks’ returns? 22 January 2024). In other words, today’s prices don’t foretell prices one month or a year hence. As a result, unless we assume that tipsters possess some special ability to divine the future, which I showed in Experts can’t predict yet investors must plan: What, then, to do? (23 November 2020) is extremely doubtful, we have no reason to expect that tips will systematically outperform.

Indeed, given tipsters’ overconfidence (which my analysis will substantiate) and overconfident people’s chronic tendency to over-promise and under-deliver, which my past articles have demonstrated, we have strong reason to expect that tips will generally underperform.

Tipping, like short-selling, is short-term speculation – and speculation is a mug’s game. For reasons I’ll detail in the conclusion, none of the forthcoming should be regarded as criticism of Livewire or its readers (as opposed to some of its "expert" contributors, who’re falsely implying that they’re prescient).

For the moment, it suffices to say that I don’t censure newsagents for selling lottery tickets; nor do I criticise supermarkets for selling junk food: in each case, they’re supplying a legal product which consumers wish to buy.

How to Experience Disappointment: Follow the Crowd’s Tips

It’s been more than five years since Livewire published The 10 most tipped stocks for 2019 (17 January 2019). That’s long enough to assess these tips’ worth both from a long-term investor’s and a short-term speculator’s point of view. To do so, I 

1. compiled total return data (that is, dividend plus capital gain, and taking into consideration issues and buybacks or shares) since January 2016 for each of these nine most-tipped stocks (in August 2021, one of them, Afterpay Ltd, announced that an American company, Square Inc. – which renamed itself Block Inc. in December 2021 – had agreed to purchase all of Afterpay’s shares; as a result, Afterpay delisted from the ASX in February 2022);
2. weighted each of these nine series (Livewire readers’ #1 pick received a weighting of 1.0, the #3 pick (Afterpay ranked #2) a weighting of 0.8, ... and the tenth a weighting of 0.1) and computed a single, weighted total return index for these nine stocks. (Results are substantially the same if equal weights are used);
3. assumed that the tips were compiled in December 2018 and assigned the number 0 to this month;
4. assigned sequential numbers (-36 for January 2016, -35 for February 2016, ..., and -1 for December 2018) to each month during the three years before the tips’ compilation;
5. assigned sequential numbers (1 for January 2019, 2 for February 2019, ..., and 60 for January 2024) to each month during the five years since the tips’ compilation.

As a benchmark, I computed a total return index for the S&P/ASX 200. Figure 1 and Figure 2 plot key results from these exercises. To abate short-term fluctuations, Figure 1 expresses each month’s total returns as compound annual growth rates (CAGRs) over the previous 24 months. For example, from January 2016 to January 2018, the tipped stocks’ weighted average CAGR was 24.8% and the Index’s was 13.1%, and so on for each successive month to month 60 (January 2024).

Figure 1: 24-month CAGRs, Most-Tipped Stocks versus Benchmark, January 2016-January 2024

Figure 1 shows that during the 12 months before (-12 to 0 on its x-axis) and after (1 to 12) the experts issued their tips, the most-tipped stocks always and significantly outperformed the Index; thereafter, they increasingly underperformed. These tips’ shelf-life, in other words, has been short-term.

The Index’s returns are trendless – its best-fitting regression line has no slope – whereas the most-tipped stocks’ returns fall steadily over time (its regression line is strongly negative). During the 12 months before and after December 2018, the most-tipped stocks’ weighted CAGRs exceeded 30%; since the end of 2021 (months 36-60) they’ve averaged 4.1%.

Consequently, although the most-tipped stocks’ average CAGR (17.5%) greatly exceeds the Index’s (9.0%), most of this outperformance occurs “pre-tip” (before month 0); “post-tip” (after month 0), the outperformance virtually disappears (Figure 2).

This result leads me to wonder (subsequent analysis will corroborate my suspicion) that these were tipped simply because they’d risen so strongly during the preceding several years. If so, that hardly demonstrates that tipsters are prescient! Quite the contrary: they fixate on the recent past and assume that it’ll continue into the next 12 months. Rather than suppose that the hefty gains of the past will regress towards the Index’s returns – which Figure 1 shows they do – they mistakenly assert that they’ll continue.

Figure 2: Average CAGRs, Pre- and Post-Tipping, Most-Tipped Stocks and the Index, January 2016-January 2024

From the point of view of those who bought these “tipped” stocks, these “post-tip” returns are in two senses disappointing. First, they’re dramatically lower than “pre-tip” returns (average CAGR of 10% versus 31%). Secondly, they’re little higher than the Index’s “post-tip” CAGRs (average of 7.8%).

How to Underperform: Heed the Crowd’s Large Cap Tips

Summarising 5,137 of its readers’ responses, on 11 January 2021 Livewire published The most-tipped large caps for 2021. Three years isn’t long enough to assess these tips’ worth to a long-term investor (for that reason, I extended the number of “pre-tip” months), but it’s more than enough to ascertain their value to short-term speculators. For these nine (again, after Afterpay was tipped its takeover removed it from the list) large caps, I replicated the steps described in the previous section; Figure 3 and Figure 4 summarise the results.

They corroborate the results of the previous section. Figure 3 demonstrates that during the 24 months before but just 6-8 months after Livewire published the tips, the most-tipped stocks consistently and significantly outperformed the Index; after 12 months, however, the most-tipped stocks increasingly underperformed. In other words, these tips’ shelf-life is even shorter than those in Figure 1.

Figure 3: 24-month CAGRs, Most-Tipped Large Cap Stocks versus Benchmark, January 2017-January 2024

The Index’s returns throughout these five years remained steady – its best-fitting regression line continues to have no slope – whereas the most-tipped stocks’ returns continued to decay increasingly over time (its regression line remains strongly negative).

Consequently, although the most-tipped stocks’ CAGR (mean of 15.9%) greatly exceeds the Index’s (8.0%), all of this difference – and more – occurred “pre-tip.” “Post-tip,” the average difference doesn’t merely disappear; it reverses.

In other words, the most-tipped large caps greatly outperformed before Livewire’s respondents tipped them – and mildly underperformed thereafter (Figure 4).

Figure 4: Average CAGRs, Pre- and Post-Tipping, Most-Tipped Stocks and the Index, January 2017-January 2024

How to Dependably Lose Money: Heed the Crowd’s Tips about Small Caps

Summarising “nearly 5,200” readers’ responses, on 13 January 2021 Livewire published The most-tipped small caps for 2021. Once again, I replicated the steps described in the two previous sections; Figure 5 and Figure 6 summarise the results. As it was with the most- tipped stocks in 2019 and the most-tipped large cap in 2021, so it remained for the most-tipped small cap tips in the latter year: their returns fell steadily over time; as a result, the regression line remains strongly negative.

Figure 5: 24-month CAGRs, Most-Tipped Small Cap Stocks versus Benchmark, January 2017-January 2024

In The myth of small-cap outperformance (14 July 2023) I wrote: “’investing’ in Aussie small-caps is like gambling: the longer you play and the bigger your bet, the more you’ll underperform the house.” Figure 5 shows that during most of the 24 months before Livewire published the tips, the most-tipped small caps mostly (and often significantly) outperformed.

From month 0, however – that is, from the moment these stocks were tipped – they increasingly underperformed; in other words, these tips had no shelf-life. After two years (beyond month 24) they generated CAGRs of -20%.

Figure 6: Average CAGRs, Pre- and Post-Tipping, Most-Tipped Small Caps and the Index, January 2017-January 2024

Consequently, the most-tipped small stocks’ CAGR (overall mean of 1.2%) greatly lags the Index’s (8.0%). Moreover, all of the small caps’ positive return occurred “pre-tip” (average of 20.8%). “Post-tip,” it collapsed to a mean of -12.2% (Figure 6). That’s a cumulative loss of 48% and total underperformance vis-à-vis the Index of 77%!

Another Reliable Way to Lose Money: Heed the Tips of “Experts”

“A handful of niche companies were tipped among the most compelling post-COVID investment opportunities at a recent ORAH Fund event,” Livewire noted in Fundies’ top 5: medtech, payments and aeronautical (30 November 2020). “Professional stock-pickers from top-performing asset managers,” it gushed, “participated in a professional investor webinar earlier this month. Each participating investment specialist was this year asked to detail one of their portfolio picks, a handful of which are revealed and discussed briefly below.”

I selected ORAH’s ASX-listed picks, together with those in Fundies' most-tipped stock picks 2021: First-half leaderboard (5 July 2021), and with one exception (these tips weren’t ranked, so I didn’t weigh them) analysed them in the same way as the preceding picks. For this crop I averaged the tips’ dates such that December 2020 is month 0. Results appear in Figure 7 and Figure 8.

Figure 7: 24-month CAGRs, Experts’ Most-Tipped Stocks versus Benchmark, January 2017-January 2024

“The ORAH Fund,” according to Livewire, “is a fund of funds aiming to produce risk-adjusted returns in excess of a composite benchmark comprising 50% of the MSCI World and 50% of the ASX 300 Index.” If the picks indicate the accuracy of ORAH’s aim, then it’s generally wide of the mark. Figure 7 shows that during the ca. two years before these alleged oracles released their predictions (months -22 to 0), these most-tipped stocks tracked the S&P/ASX 200 Index. They continued to track it almost two years (months 1-20) after they were tipped.

Figure 8: Average CAGRs, Pre- and Post-Tipping, Experts' Most-Tipped Stocks and the Index, January 2017-January 2024

Thereafter, however, they didn’t just badly underperform: after three years they generated losses (CAGRs of -10% or more). As a result, and both pre- and post-tip, these “expert” tips underperformed the Index (Figure 8).

Anticipating and Rebutting Some Criticisms

It doesn’t matter whether the tipsters are amateurs or professionals, nor whether they tip small caps, large caps or a mixture of the two: Livewire’s tips occasionally outperform the Index in the short run, but in the long run they always underperform. (I strongly doubt that tips from other financial sites are less unsuccessful).

Critics might object to this crucial result on two sets of grounds – one silly and the other substantive. The silly criticisms run along these lines: “I (or my brother-in-law, a neighbour or the loudmouth at the local pub, etc.) followed a tip to buy X Ltd and made a heap of money. Chris is therefore talking rubbish.” 

Even if it were true (by my experience, hard evidence never accompanies it) this claim is a “one-off” – it refers to one transaction at a single point in time, and thereby excludes countless other transactions over all possible points in time. This “criticism” thereby avoids any awareness – never mind consideration – of tips’ long-term average rate of success. It’s an uncorroborated non-sequitur; as such, it’s risible.

The substantive criticism runs along these lines: “I accept your conclusions as far as they go, but am unconvinced that they generalise. That’s because you’ve selected just four samples (albeit with a total sample size of almost 13,000 tips – and not necessarily random ones. If your samples are biased, then your results likely are, too.”

That’s a reasonable criticism, and there’s only one way to address it: rigorously analyse all of the tips that have ever appeared in Livewire. I’m happy to leave it to others. That’s because (here’s my tip!) it’d likely be a hiding for nothing.

And that, in turn, is because there’s a veritable Mount Everest of valid and reliable evidence, extending over more than a century, which corroborates my results. David Dreman, in his book Contrarian Investment Strategies: The Psychological Edge (Free Press, 2011, p. 182) encapsulates it.

What is the overall track record of “expert” stock tips? To answer this question, Dreman commenced with a startling particular: the annual conference of Institutional Investor magazine in February 1970. “Over two thousand strong, the delegates were polled for the stock they thought would show outstanding appreciation that year. The favourite choice was National Student Marketing – the highest-octane performer of the day.”

“From a price of $120 in February (1970),” Dreman continues, “it dropped 95% by July ... At the same conference in 1972, airlines were selected as the industry expected to perform best for the balance of the year. Within 1% of their highs, the carrier stocks fell 50% that year in the face of a sharply rising market.

Of course, these results could (like mine) merely be unfortunate chance. That possibility prompted Dreman to locate all valid and reliable studies and surveys of professional investors’ tips and their results. He unearthed 61; Table 1 summarises their key conclusions. There’s no shortage of more recent evidence which corroborates these results; but its gist differs little from its predecessors, so for the sake of brevity I’ve omitted it.

As an aside, every year over the past seven years The Wall Street Journal’s Heard on the Street columnists have tipped stocks, but I’ve been unable to locate comprehensive lists of their picks. Ditto the Sohn Hearts and Minds conference. In both cases, there’s no shortage of self-congratulatory media coverage of successful tips, but – surprise, surprise! – precious little about failures and no data about (never mind analysis of) all tips. If you possess a complete (that is, from the first year) list of either of these sets of tips, please forward it/them to me.

The results in Table 1, Dreman writes, “startled me. While I believed the evidence clearly showed that experts make mistakes, I did not think the magnitude of error was as striking or as consistent as the results make evident.”

Table 1: David Dreman’s Compendium of “Expert” Forecasts of Favourite Stocks and Industries

Alfred Cowles, a businessman and economist at the University of Chicago (and, as such, a progenitor of the “random walk” theory, whereby over the short-term stocks’ prices fluctuate randomly), conducted the earliest research. He analysed all of the recommendations of William Peter Hamilton, the editor of The Wall Street Journal and co-originator of the so-called “Dow Theory,” between 1904 and 1929.

Cowles concluded that anybody who implemented all of Hamilton’s tips over these 25 years, would, on average, have underperformed the Dow Jones Industrial Index.

During 1929-32, Cowles led three studies which assessed the record as forecasters of investment advisors, large insurance companies, brokers and bankers. Each found that the recommendations of each of these groups of “experts” underperformed the S&P 500.

More generally, 17 of the studies summarised in Table 1 measure the performance of experts’ tips. Fifteen of these 17 studies concluded that they underperformed.

This means, noted Dreman, “that when you receive professional advice about (which) stocks to buy, you would be given bad advice nine out of ten times (15 ÷ 17 = 0.88). Throwing darts at the (newspapers’) stock pages blindfolded or flipping a coin to decide what to buy would give you a 50-50 chance. Using a (mainstream) financial professional would reduce your (chances of success) considerably.”

“Overall,” Dreman concludes, “the favourite stocks and industries of large groups of money managers and analysts did worse than the market”– that is, underperformed – 76% of the time.

In 1953 and 1957-76, Trusts and Estates magazine, in its poll of several hundred banks’ and trusts’ chief investment officers, requested that they nominate their three “favourite” (from the point of view of their stocks’ expected return during the next year) industries. Table 1 summarises these surveys’ key results; Table 2 details them.

Table 2: Trusts and Estates Magazine, Surveys of Experts’ Tips, 1953-76

In seven of these 21 years, the most-tipped industry outperformed the S&P 500; and during these years, it outperformed the S&P by 13.5 percentage points. Two thirds of the time, however, the most-tipped industry underperformed; and when it did, it lagged the Index by 9.4 percentage points.

Accordingly, over the entire 21-year period the CIOs’ tips lagged the Index by an average of (0.333 × 0.135) – (0.667 × 0.094) = -1.86% per year. Over these 21 years, their cumulative shortfall vis-à-vis the S&P 500 was thus (1 – 0.0186)²¹ = -32.6%.

Reviewing the studies summarised in Table 1, Dreman asks: “what do we make of results such as these? The (size and) number of samples seems far too large for the outcome to be simply chance. In fact, the evidence indicates a surprisingly high level of error among professionals in (tipping) both individual stocks and industries over a period of (almost one century).” Accordingly,

“the (tipping) failure rate among financial professionals, at times approaching 90%, indicates not only that errors are made but that under certain conditions there must be systematic and predictable forces working against unwary investors.”

Why Do Tips Generally Fail?

What are these “systematic and predictable forces working against unwary investors”? Essentially, Dreman’s examinations of the studies summarised in Table 1

“clearly demonstrate ... that professional (and, like Livewire’s readers, amateur) investors, in the large majority of cases, were tugged towards the popular stocks of the day, usually near their peaks, and, like most investors, steered away from unpopular (stocks).”

In diametric contrast, since 1999 Leithner & Company has sought (1) to buy the securities of sound businesses (as established by our rigorous and independent research) at prices well below our conservative estimates of their values, and (2) subsequently to sell them at prices that significantly exceed our assessment of their worth. As a result, as conservative contrarians we’ve tended to hold much cash, accumulate what’s become outré and shed what’s in vogue.

In short, we’ve bought from pessimists and sold to optimists; unlike the crowd, we’ve shed what’s become popular and acquired what’s undeservedly unfashionable.

Cognitively, most people can readily understand this approach; perhaps for that reason, more than a few allege that they practice it. Psychologically, however, that’s insuperably difficult to do – and to my knowledge, only a few investors – whether professional or amateur – actually do.

Most “investors” (who are actually speculators) regularly claim that they think for themselves and, when necessary, boldly defy the crowd. In reality, they submissively crave the warm glow of consensus and abhor the chill wind of independence – and their attitudes towards and behaviour in reaction to tips demonstrates it.

It’s apparently “better for reputation,” as the British economist, John Maynard Keynes, famously quipped, “to fail conventionally than to succeed unconventionally.” The problem, as Warren Buffett phrased it in a much-lauded but seldom-read and thus rarely-heeded article, is that “You Pay a Very High Price in the Stock Market for a Cheery Consensus” (Forbes, 6 August 1979).

If, as we’ve seen, following the herd typically begets underperformance and can be dangerous, then taking one’s own counsel can generate big rewards. Yet most take the popular (speculative) highway and few choose the investment road less travelled. The latter is solitary, and often elicits criticism and occasionally even ridicule. Fortunately, its eventual financial benefit usually outweighs its transitory social cost. “Most people get interested in (a company) when everyone else is,” Buffett told Newsweek (“Omaha’s Plain Dealer,” 1 April 1985). Yet “the time to get interested is when no one else is. You can’t buy what is popular and do well.”

A quarter-century later, in his Letter to Shareholders (2009) – which, significantly, appeared towards the nadir of the GFC – he elaborated:

A climate of fear is (our) best friend. Those who invest only when commentators are upbeat end up paying a heavy price … In the end, what counts in investing is what you pay for a business – through the purchase of a small piece of it in the stock market – and what that business earns in the succeeding decade or two … The obvious corollary is to be patient. You can only buy when everyone else is selling to you …

“None of this means, however,” he elaborated in his Letter (1990),

that a business ... is an intelligent purchase simply because it is unpopular; a (thoughtlessly) contrarian approach is just as foolish as a follow-the-crowd strategy. What’s required is thinking rather than (consensus). Unfortunately, Bertrand Russell’s observation about life in general applies with unusual force in the financial world: “Most men would rather die than think. Many do.”

Testing Buffett’s and Dreman’s Insights

To “value” (but not “growth”) investors, a high price-to-earnings (“PE”) ratio likely means that a company’s stock is unduly popular – and thus overpriced and ripe for an eventual fall. Value investors generally shun high-PE stocks because the evidence is overwhelming: on average and over the long term, they generate sub-par returns. 

“Growth” investors agree that high-PE stocks are popular stocks. That’s because they expect (mistakenly on average – see Do earnings drive stocks’ returns? 22 January 2024) that their earnings – and thus rates of return – will rise strongly in the near future.

I’ll therefore use the PE ratio to gauge stocks’ popularity: if you’re a growth investor, you’ll seek such stocks because they’re popular; if you’re a value investor, you’ll shun them – because they’re popular!

If Dreman (“investors ... are tugged towards the popular stocks of the day”) and Buffett (“you can’t buy what’s popular and do well”) are correct, then I expect that highly-tipped stocks will also be high-PE stocks; consequently, they’ll generate sub-par long-term returns.

Figure 9: PE Ratios, Most-Tipped Stocks versus Benchmark, January 2016-January 2024

Figure 9 plots (1) the weighted PE ratio of Livewire readers’ most-tipped stocks in January 2019 and (2) the Index’s ratio. (Again, unweighted data produce essentially the same results.) In three respects, it corroborates Buffett’s and Dreman’s expectations:

1. Without exception, the most-tipped stocks’ weighted PE ratio exceeds the Index’s; the most-tipped stocks, in other words, are invariably more popular than the overall market;
2. During the three years (months -36 to -1) before the tips’ publication, the most-tipped stocks’ weighted PE tended to rise; during the two years (months 1 to 24) after publication, it plateaued; thereafter, it tended to fall. As a result, the weighted PE’s best-fitting line is perpendicular. In contrast, throughout these five years the Index’s PE was trendless.
3. During the three years before and two years after the tips’ publication, the most-tipped stocks outperformed the Index (partly) because their weighted PE ratio greatly exceeded it; thereafter, however, as their PE (popularity) regressed to the Index’s, they increasingly underperformed.

The large-caps tips produced results that roughly resembled those in Figure 9; so did the experts’ tips. For reasons of brevity, I’ve therefore omitted them. I couldn’t replicate this analysis with the most-tipped small caps: only one of the ten possesses a consistent record of profitability; the other nine generated losses during most or all of the years since 2017.

What about Livewire’s Latest Tips?

What do the foregoing results imply about today’s tips? Among other things, that The 20 most-tipped ASX stocks for 2024 (15 January 2024) will, by and large, disappoint – or worse.

Almost 5,000 of Livewire’s and Market Index’s readers submitted their picks and Livewire rank-ordered them (i.e., the most-tipped stock ranked #1, the second most-frequently tipped one ranked #2, etc.).

I then divided these tips into two groups: the top-ten and numbers 11-20. I assume that readers submitted their selections in December, and labeled it month 0. The next month, January 2023, is thus month 1, and the nearest pre-tip month, November 2022, is month -1, and so on to January 2016 (month -95). That’s eight years of monthly observations – all but two of them occurring before the tips’ publication.

We can’t know how these tips will fare in the future, but we know exactly how they’ve fared over the past eight years. Their past track records won’t please people who’ve heeded them and are expecting outperformance.

Figure 10a: 24-month CAGRs, Livewire Readers’ Top-Ten Tipped Stocks versus Benchmark, January 2016-January 2024

Figure 10a plots the top-ten stocks and the Index’s 24-month CAGRs; Figure 10b does the same for the stocks ranked 11-20. They reconfirm the gist of what my previous analyses have demonstrated:

1. during the almost six years (95 months) before readers submitted their tips, these stocks, considered as a whole, always – and, for the most part, greatly – outperformed the Index;
2. as time has passed, however, the extent of the outperformance has diminished more (Figure 10a) or less markedly (Figure 10b);
3. consequently, over the past two years (months -25 to -1) the top-ten stocks’ CAGRs have mostly tracked the Index’s;
4. both groups’ CAGRs trend downwards; the Index’s, on the other hand, is trendless. As in previous samples, so in this one: the tipped stocks’ CAGRs regress towards the Index’s.

Figure 10b: 24-month CAGRs, Livewire Readers’ 11^th-20^th Tipped Stocks versus Benchmark, January 2016-January 2024

If, as “growth” and “momentum” investors often assert, “the trend is your friend,” then it’s very hard to contend that during the next year the top-ten tipped stocks will greatly outperform the Index.

My previous results, in David Dreman’s words, “clearly demonstrate ... that ... investors, in the large majority of cases, were tugged (by tips) towards the popular stocks of the day, usually near their peaks, and, like most investors, steered away from unpopular (stocks).” Figure 11a and Figure 11b corroborate this generalisation.

Figure 11a: PE Ratios, Top-Ten Tipped Stocks versus Benchmark, January 2016-January 2024

Importantly, I calculated PEs only for companies with a consistent record of earnings. This excluded a significant number of companies, particularly from the lower half of the picks ranked 11-20. The top-ten tipped stocks are more popular (mean PE ratio of 21.9) than the Index (17.3).

Moreover, with just one exception these stocks have always, each month over the past eight years, been more popular than the average stock (Index). And their popularity is trending upwards, whereas the Index’s is trendless.

Anybody who’s recently purchased the 11^th-20^th ranked stocks should understand the considerable risk he’s taking. These stocks’ PE ratio has averaged 25.5, but has trended upwards, and currently exceeds 50 (Figure 11b).

Figure 11b: PE Ratios, 11^th-20^th Tipped Stocks versus Benchmark, January 2016-January 2024

The owners of high-PE stocks, it’s important to emphasise, expect (mistakenly – see Do earnings drive stocks’ returns? 22 January 2024) that their earnings and thus rates of return will shortly rise strongly. What happens when they don’t? Their prices typically crash. Male investors should tattoo Warren Buffett’s admonition to their forearms: “you can’t buy what’s popular and do well.”

If past is prologue (that is, Livewire readers’ sample of latest tips derives from the same population as those in 2019 and 2021), what can we expect during the next year and beyond?

During the next year, these stocks’ prices, like all stocks’ prices, will generally fluctuate randomly. Maybe the tipped stocks will outperform the Index; maybe they won’t; either way, results will be more a matter of chance than tipsters’ insight.

Over the next few years, the top-ten picks’ overall CAGR likely won’t – since over the past eight years they’ve regressed to the Index’s – vary greatly from the Index’s. This, perhaps, will disappoint those who’ve heeded these tips; it won’t, however, wreck their finances.

However, given their sky-high average PE ratio, people who purchase weighted or equal dollar amounts of the 11^th-20^th picks should prepare to lose a considerable portion of their outlay. This loss mightn’t occur during the next 12 months (over the short term, remember, prices generally fluctuate randomly), but is much more likely to happen during the next several years.

Conclusions and Implications

It doesn’t matter whether the tipsters are amateurs or professionals, nor whether the tips are small caps or large caps: tips occasionally outperform in the short run, but over the long term they usually underperform – or worse.

Like magicians (don’t look there – look here! And for God’s sake, don’t look at the results of my previous tips!), tipsters divert attention from the past (which, for those with the energy to investigate it, is objectively knowable) to the present (which, tipsters allege, is rosy) and the near-term future (which is random but, they incorrectly assert, will be much like the present).

It’s therefore vital to appreciate: tipsters aren’t prescient. Quite the contrary: they fixate upon the recent past and assume that it’ll continue into the next 12 months. Moreover, to conform to the consensus and maintain their popularity, they mostly tip popular (high-PE) stocks.

It’s even more vital to understand: you can’t buy what’s popular and do well. Rather than suppose that trendy stocks’ hefty gains of yesterday will eventually regress towards the Index’s returns, today’s tipsters mistakenly assert that they’ll continue. What, then, to do? If you wish to invest sensibly and successfully, you must (1) never heed tips, (2) always think for yourself and above all (3) conduct your own thorough due diligence – “pitches” don’t cut it.

If you’re able to do these things, you’ll seek and selectively buy the shares of undeservedly unpopular companies; if you’re unable, however, then you must find someone who can.

Cognitively, conservative contrarian investment isn’t easy, but many people could probably manage it if they tried; psychologically, however, for most it’s well nigh impossible. That’s because somebody, somewhere, will buy a stock or two on the basis of a tip, and within a year their prices will skyrocket. He’ll crow far and wide about his alleged prowess (the much larger number of people who lose money will be largely silent), and in response others will kick themselves: “why didn’t I buy the same stocks at the same time?”

That’s the bait that converts initial curiosity about tips into the habit of seeking tips. It’s the same lure that, week after week, tempts more than eight million Australians collectively to purchase ca. $7 billion dollars worth of lottery tickets (that’s an average of almost $900 per buyer) per year.

The insuperable problem for speculators is that investing on the one hand and gambling and speculating on the other face very different odds: gambling and speculation suffer from comparatively long odds, and investment worthy of the name benefits from relatively short odds. People who heed stock tips are – perhaps unwittingly – speculators: as such, and surely unintentionally, they stack the odds against themselves.

Tips comprise much of the content of many financial web sites. Yet tips generally fail; hence much of the content of most financial sites does more harm than good.

In that sense, and just as supermarkets are purveyors of junk food, financial web sites disseminate junk information.

Junk food occupies a considerable portion of supermarkets’ shelf space; it also generates a proportionate percentage of their profits. My guess is that tips generate the lion’s share of financial sites’ traffic. Supermarkets and financial sites feature – indeed, direct attention to – these items because many people want to consume them.

Yet just as one biscuit per day or an occasional sweet or small packet of crisps, in the context of a good diet, is harmless to health, an infrequent flutter of a few dollars on a lottery ticket or a “hot stock tip” does no damage to finances. At the beginning of this article I emphasised that tips aren’t illegal; I now add that they’re not intrinsically immoral. They’re merely dumb.

The problem – and it’s a big one – arises when tips’ consumers fundamentally misconceive their nature. Do tips reflect the wisdom of the crowd? Livewire thinks so (see in particular The 20 most-tipped ASX stocks for 2024, 15 January 2024), but that’s obviously and demonstrably false: as Dreman’s meta-analysis demonstrated and my analysis has reiterated, tips generally fail; clearly, however, what generally fails in the long term can’t be wise.

Instead, my and others’ analyses of tips support John Maynard Keynes’s contention: in the short term, financial markets resemble a kind of beauty contest. The wisdom of the crowd reflects the collective judgement of a group whose members form judgements independently; in Keynes’s beauty contest, views are anything but independent.

In this contest, “judges” (tipsters) receive “rewards” (recognition from followers, mainstream media, etc., as “gurus,” high salaries from employers, etc.) for correctly selecting those “faces” (stocks) which, they believe, others will agree are the most popular speed-dates (likely to generate the highest returns in the short term) rather than those they may believe will make the most suitable spouses (long-term investments).

Yet others’ assessments are volatile; hence tipsters are fickle. Partly for this reason, stocks’ day-to-day, week-to-week and month-to-month prices are subject to unexpected (that is, random) fluctuations from optimistic to pessimistic sentiments and vice versa.

Richard Thaler is Professor of Behavioral Science and Economics at the University of Chicago. In 2017, he was awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (universally but erroneously known as the “Nobel Prize in Economics”). In his highly readable and informative book Misbehaving: the Making of Behavioral Economics (W.W. Norton, 2016), he concludes that, in the short term, “Keynes’s beauty contest analogy remains an apt description of how financial markets work;” it’s also “an apt description of what (mainstream) money managers are trying to do.”

I therefore conclude where we began: stock tipsters and their followers are a prime example of Mr Market in action. He “is there to serve you, not to guide you,” wrote Warren Buffett ... If he (is) ... in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.”

If you don’t understand the insidious nature of stock tips – like junk food and lottery tickets, their long-term expected value is negative – you shouldn’t be investing. Above all, if you heed tips without doing your own thorough due diligence, then you're the patsy. Caveat emptor!

Click LIKE so that Livewire knows that you want more of this type of content. Click FOLLOW on my profile for notification when my next wire appears.