Core Conviction #2: Doing Your Homework is OverratedDec 17, 2021
Have you ever received a recommendation from your advisor, investment guru that you followed, a friend or someone you trust about a specific stock that he thinks is about to move? And he claims the company is doing these amazing things, and it's a rare opportunity. You dug up the information yourself to verify. You bought some shares of the company and, it happily goes up after that. But then it starts to go down after a while, and it gets lower and lower. Your trusted "adviser" (could be your brother or sister) keeps telling you all the reasons why it shouldn't be. The thing is that all the good things you hear about the company may turn out to be true. Both you and your trusted "adviser" have done your homework diligently. But here is the point: there is a disconnect between what you know and what the market knows, and as a result, the share price of the company that you research may not react to what you expect. This often leads to confusion and frustration, not to mention holding on to an investment that is causing you anxiety every day.
Doing your homework is highly overrated. That is again one of those unspoken secrets that all investment professional knows. There is quite a bit of information and knowledge asymmetry here. Of course, you should all check out the best deposit rates, the best CPF policy, the best insurance plan that saves you money. The amount of potentially helpful information is endless. But in most cases, the advice "Do Your Homework" refers to "Researching a stock".
I am going to attempt to convince you in this article why most investors, including me, do not have the time, tools and skills required to do homework at the needed level.
First, let's talk about time. For most retail investors, investing is not a full-time endeavour, even for a retiree. And when you are competing in a field that is so competitive, you know for sure that millions around the world are doing this on a full-time basis. You have to realise that you do not have the edge over these full-time market participants. Warren Buffett and Charlie Munger reportedly spend a significant amount of time reading periodicals, books and filings to arrive at their insights. Can you commit to the same rigour? Do you have an interest to engage in these investigations?
The second obstacle concern the tools you used. Most people's tools are the proverbial hammers used to solve every single kind of problem out there. Their hammer is Google. They perform their research using just Google. They type in the company's name, and sure enough, there is a blog written about the same company they are researching. Best of all, this blog is free. What most people don't realise is that there is rarely such thing as free investment research. Good quality research costs money.
On top of that, investment professionals don't simply google for the information. They have access to tools like Bloomberg terminals, CapitalIQ from S&P, and various data feeds from Interactive Data, IHS Markit and Refinitiv. If you have no idea what I am talking about, don't worry about it. These are the tools that professionals use to conduct their research.
Finally, there is the issue of the skills set required. Most "do your homework" advice exhorts you to read the annual report and quarterly reports, study balance sheets and exchange filings, listen in to conference calls and read all the analysts reports you can.
For example, an adviser might say things like before you buy a bank, find out about its net interest margin and non-performing loans. If it is a Telco, dig out its enterprise value. Or, if it is a REIT, find out about its DPU and whether it can maintain this DPU forever. The advice is sound, but do you have the skill set to do that. More importantly, does it matter? Of course, you can get a professional to do the homework for you if you can afford it. But most of us don't have the skill set. We are not trained to analyse cash flows, net interest margin, cash conversion cycle or the financial statement footnotes.
What good is "Doing Your Homework" then?
The above assertion about doing your homework is counter-intuitive and also controversial. This is something that has taken me over a few decades to discover. I mean well when I say doing your homework is overrated. And if my assertion is correct, most people do not have the time, skill, and tools to do proper stock-specific research, much less predict how the market will react to your research. Perhaps it is time for a new mindset on properly spending your time allocated to doing your homework.
First, develop your financial literacy skills. I am not saying that you must be proficient in reading the annual reports and computing the cash conversion cycle. At a minimum, reach a level that will allow you to appreciate reading the common business news such as WSJ and FT.
Second, don't get scams, including what appears to be a legitimate investment scheme. If unsure, check the MAS or your local regulatory authority's website. I recently sent an email to MAS and got a reply within a week on a company that I intend to invest with. You can do the same. Do check out MAS's investor alert list.
Third, study Charles Ellis on how to win the loser's game. I am talking about reading great investment books here. The choice between devoting three hours it takes to read Charle's Ellis' Winning The Loser's Game or using the time to study stock-specific reports is a no-brainer.
If you have time to do both, then that's fine. Reading the annual report and stock exchange filings may not help you succeed as an investor, but reading Berkshire Hathaway's annual shareholders letter (aka Warren Buffett's letter) will make you a better long-term investor. This would definitely improve your financial literacy skills as well.
There are also a few out of millions who have spent their time in the market, and they are gifted enough to be able to see the truths that others don't and then write down their findings in a book. The more wisdom we can get from these elite thinkers, the more likely we will be successful long term investors.
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