Hang out with losers if you want outstanding results in the stock market

Johnny HopkinsResearch, Resources, StudyLeave a Comment

(Image, Do You Have a Friend Who is a Loser? Get Rid of Em!, accessed 18 July 2016, http://persuasive.net/)

Let’s face it, no-one wants to hang out with losers.

But when its comes to investing, these are the exactly the types of stocks most likely to provide outstanding returns.

The problem is there’s one undeniable fact in stock market investing and that is that human beings are drawn to the beautiful, high growth, glamour stocks.

It’s not just in the stock market, it seems that human beings are simply attracted to attractive things.

One study, a 1987 study by Judith Langlois, PhD, published in Developmental Psychology, showed that infants as young as two months prefer to look at pretty faces when they probably haven’t had the chance to pick up many cultural cues about beauty.

The New York Times reports, “Brain scan studies reveal that the sight of an attractive product can trigger the part of the motor cerebellum that governs hand movement. Instinctively, we reach out for attractive things; beauty literally moves us.”

And, it’s the same in the stock market.

Let’s say we’re hanging put with our buddies at a cocktail party and we start talking about stocks. No-one wants to talk about the beaten down stock that just dropped 20%, everyone wants to focus on the latest stock market darlings. Historical research however, tells us that these beaten down losers are precisely the types of stocks that are most likely to out-perform.

Tobias Carlisle, the founder of this website, wrote a whole book, Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, about the opportunities provided by these unpopular stocks.

Tobias refers to research, Does The Market Overreact, conducted by two economists known for research into both market behavior and individual decision-making, Werner De Bondt and Richard Thaler. De Bondt and Thaler speculated that investors tend to “overreact” to unexpected and dramatic news events, both positively and negatively.

Using data for the period 1926 to 1982, they formed portfolios of the 35 most extreme winners (those that had risen the most), and the 35 most extreme losers (those that had fallen the most) measured over the 3 years before the selection date. They then tracked the subsequent 3-year performance of the portfolios.

Figure 5.1 (below) shows the performance of the portfolios of Losers (those that had fallen the most over the prior three years), and the Winners (those that had risen the most over the prior three years).

They reported that, they’re “results are consistent with the overreaction hypothesis”.

“Over the last half-century, loser portfolios of 35 stocks outperform the market by, on average, 19.6%, thirty-six months after portfolio formation. Winner portfolios, on the other hand, earn about 5.0% less than the market, so that the difference in cumulative average residual between the extreme portfolios, equals 24.6%.

So you see, hanging out with losers is the best way to get outstanding results in the stock market. The trick is, to pick the beaten down stocks that have the best chance of outperforming and that’s why I use the screens here at The Acquirer’s Multiple.

A concentrated portfolio of value stocks, like the ones provided here at The Acquirer’s Multiple, have historically proven to be one of the most successful methods of achieving long term out-performance in the stock market.

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