Why You Should Never Follow Gurus

Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

One of the most seductive things for a private investor is reading an article by an investment guru or pundit that writes or screams about trading a certain stock or asset class. In addition, I frequently see articles that monitor their positions and what they buy and sell. It’s all so easy. You just follow a guru-who has no doubt put in a lot of research--and you make money. It’s so simple and you can just sit back and let them do all the work. Alas, it’s not so easy and here is why.

Why You Shouldn’t Take Gurus Too Seriously

I’m going to summarize the main arguments and then flesh them out.

  • Real time observations: Are you able to monitor exactly when they enter and exit positions? And when they change their minds?
  • Deliberate obfuscation: It’s a nasty zero sum game world out there, and some people deliberately want you to trade opposite to them. Think of Jim Cramer and his infamous ‘moron longs’ observations.
  • Track record: Are these guys actually any good? What do you really know about their track record and do they consistently make money or is it just a year or two of good numbers when the market favors their strategy? Why is it so hard to find a track record for some of these guys?
  • Timing: Are you in the position at the right time or is the guru the only one making money?
  • Portfolio positioning: Do you understand how the position works within their overall portfolio or are you looking at it in isolation?

 

It’s all very well reading the myriad reasons why someone wants to buy something, but what about when they want to sell? What about when conditions change and a disciplined ‘guru’ then suddenly changes his mind? I doubt he is going to email you personally to let you know. Moreover, let’s say that you learn that one of them has just sold his entire position in, say, Costco. You get all excited and dump your entire holding but what if he sold his because he wanted to shift into Wal-Mart and Target on a relative value basis? This doesn’t mean he’s expressing anything negative about Costco. On the contrary, it could be positive, but it just means he prefers other stocks in the sector.

Moron Longs

It should not be lost on investors that there are lots of scurrilous people out there who spread rumors and counter-rumors in order to manipulate investors and sometimes it is in the opposite direction of which way they are actually trading.

In recent years there have been examples of financial institutions setting up products in order to sell investors and then short them or their constituents. Similarly, it’s so easy for an investor who wants to sell a position to try to encourage others to buy it so he can get his exit cleanly. Always ask why someone wants to tell you about his position.

How Good Are These Guys Anyway?

Okay, I confess I have a bee in my bonnet about this. Investment management lives off numbers, performance and results. There is no end to the metrics that have been devised in order to monitor these things mathematically. Well in that case, why on earth is it so difficult to find a track record for many of these guys? I doubt anyone markets more than, say, Ken Fisher but I suggest Googling around and trying to find a discernible long term track record for the guy. Similarly, some investors are great in certain periods but they may not perform in others.

I learn this lesson to my own regret. Now I respect Warren Buffett more than most investors and have written about his long term track record here, however, there are certain types of stocks that I have learned to avoid with him. A few years ago I recall buying H & R Block (NYSE: HRB) and Iron Mountain (NYSE: IRM) and feeling good because Buffett held position in the stocks. The logic seemed clear. HRB had a natural moat with its tax services and was expanding into Wal-Mart locations. It was cash generative and had obvious long term prospects. Similarly, Iron Mountain’s document storage was a long term recurring revenue generator and a service that certain industries could not do without. It all made sense. Right?

Well HRB turned out to be on the cusp of losing market share to Intuit thanks to its do-it-yourself software and cloud offerings. IRM discovered that electronic storage can replace much of the need for document storage. Lesson learned. Buffett is not that hot in industries susceptible to technological changes. Maybe this is because of his famous aversion to buying technology stocks?

Timing

This argument is simple. It is all very well to follow a guru ‘with a view’ but you have to be in the position at the right time. For example let’s look at GameStop (NYSE: GME), Herbalife (NYSE: HLF) and Nu Skin Enterprises (NYSE: NUS).  I wouldn’t buy these stocks if you paid me to, but I would be very cautious about shorting them despite the amount of negative feeling that some ‘gurus’ have over them.

Here is why.

 

<img src="http://media.ycharts.com/charts/4514f78e2e6c3b09e250cf9807df2734.png" />

HLF data by YCharts

As much as I dislike Nu-Skin and Herbalife, the fact is that until a notable hedge fund manager comes out and states his negative case over the stock you could find yourself losing money. The reason is that so many nervous shorts hold these positions and worried buyers stay away. Therefore any positive news sees them rising and the shorts close out. You can see this with GameStop.

In addition, investors need to be in the position before the guru speaks, but how do you know when he will do that? And why short a stock after the big move down. The few big down moves took place over a few days in the year!

Portfolio Positioning

This is probably the most important aspect. Investors buy stocks for all sorts of reasons, and you need to understand how a stock works in a portfolio. So, for example, what is the point of talking about a short/long position in a stock if a hedge fund manager is long/short another stock in the sector with a relative value pairs trade.  Similarly, some managers buy stocks in order to thematically hedge against overweight positions in their portfolio or they buy them in order to try some form of corporate action. The reasons are myriad and investors should not look at one position in isolation.


SaintGermain has a position in Intuit. The Motley Fool owns shares of GameStop. Motley Fool newsletter services recommend GameStop. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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