How You Can Beat Wall Street at Their Own Game

Stock analysts are actually incredibly biased when it comes to making recommendations. Here are three ways to beat them -- and yourself.

Jun 15, 2014 at 12:30PM

Flickr / nromagna.

For all their efforts, analysts tend to be wrong, not only because forecasting is tricky, but because of psychological biases that can affect all investors. Here are a few tips to avoid the pitfalls that so many analysts (and other investors) tend to fall into. 

Think forward, not backwards
Analysts often work for large banks, which provide underwriting services to the same companies these analysts are writing about.

Bad reviews are associated with losses of access to management and the switching of underwriters, so analysts have an incentive, however subtle, to be more optimistic than they should be. This ends up affecting their reports and recommendations -- studies find that analysts tend to give in to their optimistic biases.

You, of course, don't face the same conflicts of interest with the companies you're analyzing, but you might be facing conflicts of interest within yourself.

These usually take the form of looking for evidence that confirms the things that you want to be true, either because you're literally invested in the result, or because it would be a blow to admit you're wrong. 

Flickr / Anderson Mancini.

Behavioral scientists call this confirmation bias. It's like selective listening: You hear what you want to hear and filter out the rest, regardless of whether it's important or not. The problem with confirmation bias is that you end up ignoring evidence that goes against what you already believe, and you don't apply rational analysis to the evidence that supports your beliefs.

How to avoid it? Deliberately seek out information that disproves what you believe, whatever it is.

This can be hard to stomach at first, but if you make it a habit with every investment, you might find that it becomes kind of fun. Take your investment thesis, whatever it is, and actively try to prove yourself wrong. You might find that your beliefs hold up, or you might develop a more nuanced one. You might also completely change your mind. 

Familiarity should breed contempt
Okay, maybe not contempt, but certainly suspicion.

Analysts tend to ignore a lot of stocks -- the result is that a lot of analysts cover large banks, like Bank of America, and very few cover small banks.

Part of the reason for the oversight might be the conflicts of interest described above, but it might also have something to do with familiarity. We are simply more comfortable with what we know, even if that just means recognizing a brand name. This explains why you might tend to walk into a Starbucks whenever you're traveling, instead of trying out a local coffee shop.

Try to recognize that you might be predisposed to a stock simply because you're hearing about it all the time.

Like most things in the media, a company isn't necessarily better just because everyone is talking about it. Try to give time and analytical horsepower to stocks that are outside the popular investing universe -- you might come up with some crazy ideas, but you may also find greener pastures.

Flickr / thenails. 

Following the herd 
Similarly, research has also found that analysts tend to be followers; for example, they tend to be the most pessimistic after the worst part of a downturn, when things are already looking up. We do the same thing as investors. Even though everyone knows you should buy low and sell high, it's awfully hard to do when everyone around you is in a buying frenzy -- or running for the exits.

How to avoid falling into the trap? Adopt that timeless wisdom of Warren Buffet, "Be fearful when others are greedy and be greedy when others are fearful." If you're feeling giddiness in the market, take note. Same goes for panic. 

All in all, take pride in being on your own as an investor instead of worrying about what everyone else is doing. It will be hard, and it will certainly be a bit lonely, but it will set you apart from the analysts -- not to mention everyone else.

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4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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