I once met an alumnus from my graduate school who worked as an analyst on Middle East security issues in the Office of the Secretary of Defense. I asked him the classic "moral dilemma" question for government workers: What do you do if you don't agree with the policy of the administration you are working for?
"No one ever asked me what I think about our policies," he replied.
His job was to analyze events and their implications in the Middle East for people much higher up the food chain. Those people then argued with other policymakers about U.S. policy. No one paid the analyst to think about policy options, and no one cared what he thought about them.
That's why most people in the financial-services world have little imagination when it comes to stocks and the stock market. No one pays them to think creatively; they're all stuffed full of preapproved models and slogans and "investment products" to peddle to corporate and retail customers.
Thinking inside the box
Narrow-minded Wall Street thinking is behind much of the cliche-ridden jargon we hear every day. Here are a few sacred cows from the model-driven crowd that make my teeth grate:
- "Asset classes"
- "Asset allocation"
- "Average P/E for large cap/mid-cap/small-cap stocks"
- "Expected earnings for large cap/mid-cap/small-cap stocks"
The Wall Street automatons are taught to stay inside their fixed view of the world and draw simple conclusions from a limited number of plain, uncomplicated blocks in front of them. They watch "asset classes" and market indexes and capitalization groups to decide whether they should choose Door No. 1, Door No. 2, or Door No. 3.
Yes, much of Wall Street is just a hyped-up version of Let's Make a Deal.
Don't be an automaton
The automatons don't care much about earnings reports, except when it comes to the biggest of the big caps, whose numbers set the tone for various "asset classes" and indexes. Why read 10-Qs or 10-Ks over lunch when you can schmooze clients instead?
These corporate bosses of the automatons know that their subordinates should not be allowed much independent thought, so they lavish small fortunes on overpaid analysts who feed the automatons a steady diet of "recommendations" that academics have proved to be inferior to simple index investing. These are the analysts who told you to buy Wal-Mart
When I moved to Amsterdam in 2002, I made a list of Dutch companies that trade on U.S. markets. Apart from the obvious suspects such as Phillips
Analysts are shoeboxed into discrete niches and given a limited pool of stocks to cover. They can't just pick up a magazine, read about a new company or trend, and decide to capitalize on an opportunity they just figured out, not unless it's already in their intellectual backyard. Even then, their bosses won't approve coverage if the company is too small to bring in much investment-banking revenue for the firm.
Analysts exist to take the companies on their work-assignment list and dissect them down to the last paper clip. Then they try to be better than the people who actually run the companies at guessing how those companies will do next quarter. The rest of the automatons make loud noises that sound good or bad, depending on how close the analysts' guesses came in.
The key to investing success
The successful people I know in the investing world are all chock-full of curiosity and imagination. They read voraciously and constantly look for new ideas and insights into new investments. Much like hardcore collectors at a baseball-card show, they will sift through hundreds or thousands of ordinary cards looking for that special rarity that really adds value to their collection.
Contrast that with the Wall Street automaton who sticks to reciting his mantra: "Research shows you should have 65% of your portfolio in stocks, 30% in bonds, and 5% in money market cash funds. Since we believe that small caps are overpriced at an average P/E of 25, we recommend overweighting U.S. large caps in your stock portfolio."
A broker like that drove me to take over managing my own portfolio a decade ago. That portfolio is up roughly 10 times since then. His recommendations aren't.
Asset allocation is for people who can't be bothered to build a real portfolio of promising stocks. Falling back on cliches like "small caps are overvalued" is like saying "American women are too tall." There are nearly 150 million American women of all shapes, sizes, races, and heights. Can a generalization across such a broad group be useful?
Of course not. "Asset classes" cover literally thousands of stocks in hundreds of sectors and niches. I couldn't care less what the "average P/E" is for small caps, mid-caps, the S&P 500, or any other group.
International stocks get the same cursory treatment. The typical automaton will say, "Growth looks good in Europe now." Which countries? Which companies? Which sectors? You can take an average of all of them, but it's meaningless mush if you plan to build your portfolio one stock at a time.
I care about the average P/E in my portfolio, the stocks I choose to own right now. I aim to keep that in the mid-teens as a margin of safety.
Don't let the automatons fool you into believing blanket statements about groups of stocks or countries that are far too large to mean anything. The automatons talk that way because they aren't paid to think creatively.
But you are. Just use your imagination.
For related Foolishness, see " Analysts Running Scared."
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Fool contributor Dale Baker, a private-client portfolio manager and former U.S. diplomat with extensive experience in Europe and Africa, owns shares in Wendel Investissement for himself and his clients. He is happy that the top 10 stocks in his portfolio are never mentioned on CNBC, and he welcomes your questions and comments at firstname.lastname@example.org. The Motley Fool has a disclosure policy.