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A Hot Pick for 2011: Don't Pick Stocks That Start With

This would be funny, if it weren’t so sad.

Evidence shows that stock-picking investors may be better off choosing what the stock analysts scorn than what they recommend. That’s right, the stock analysts — the folks who are supposed to be the ones in the know — seem to be better at identifying ho-hum than hot returns.

I was reminded of this concept when I read Brett Arends’ well-researched Wall Street Journal article, “Why You Shouldn’t Trust Wall Street’s Top Stocks for 2011.” While we’re all bombarded by a barrage of daily stock tips, how many of them do you actually remember a year later, to assess how they did? To complete that assessment, Arends contacted Thomson Reuters, a firm that actually tracks all those Wall Street analyst recommendations over the years. He asked them for the analysts’ past collective opinions on their top 10 stock recommendations for companies they believed would fare well above the average in the year ahead. Then he asked for the performance numbers on the 10 least-liked stocks, from the same analysts for the same projected year.

What were the results? You guessed it; the company stocks that were least liked by the analysts handily outperformed the analysts’ darlings.

And this is not a new phenomenon. I have in my archives a reprint of an April 2005 article, also from The Wall Street Journal, entitled, “Analysts Keep Misfiring with Sell Ratings,” by E.S. Browning. Browning conducted similar research and found similar results; the stocks that the analysts recommended the public should SELL, handily outperformed the stocks with BUY ratings.

So what are the implications of this arm chair journalistic research? Probably nothing. I’ll get to why that is in a moment. But, if you are an investor (anyone invested in publicly traded stocks or bonds, whether individually held or through mutual funds), and your broker makes recommendations based on those sage analysts’ recommendations, proceed with caution.

Better yet, don’t proceed at all. There’s a better way than trying to pick the big winners or avoid the big losers ahead of you.

The evidence is pretty clear. Whether they’re a banker, financial analyst or candle-stick maker, no one can predict the future with any consistency or accuracy over time. Some may capture our attention by their short-term winning streaks, or the emotional appeal of their opinions, but the gorilla in the room remains: there is scant evidence of long-term positive results, especially after you consider the costs of implementation. It’s all about short-term performance and being better than the competitor across the street, so they take their chances — and so does anyone who invests according to their recommendations.

Instead, your best odds for capturing reliable market returns is to pass on the stock-picking game entirely. Get down to business with a globally diversified portfolio that exposes you to a wide range of market returns in accordance with your personal financial goals and risk tolerances. Based on the evidence on how markets deliver their returns (rather than the prognostications of those who are getting paid to second-guess the market), you’ve got a much higher probability of achieving your personal financial goals across your lifetime. Contact me to see how this is done.