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The Skeptic’s Guide to Stock Tips
Posted By Barry Ritholtz On February 7, 2004 @ 11:06 am In Apprenticed Investor,Investing,Markets,Psychology,Rules,Trading | Comments Disabled
NOTE: I originally wrote this in 2000, and published it in 2001. I’m moving it here from geocities, before that site crashes and burns . . .
The Skeptic’s Guide to Stock Tips What to do the next time you hear about a "Sure Thing"
Skepticism’s bad rap arises from the impression that, however necessary the activity, it can only be regarded as a negative removal of false claims. Not so… Proper debunking is done in the interest of an alternate model of explanation, not as a nihilistic exercise. The alternate model is rationality itself, tied to moral decency–the most powerful joint instrument for good that our planet has ever known.
-Stephen Jay Gould
I get about a dozen “hot” stock tips a day; It comes with the territory of being a market professional.
The vast majority of these “tips” are for horrific little stocks that don’t have a snowball’s chance in Hell of ever amounting to anything—at least not on a sustainable basis. In fact, many so-called tips are nothing more than the work of stock touts—paid weasels whose sole job in life is to run up the price of some worthless piece of junk so unscrupulous sellers can exit at a desirable price. The “tip” investor is usually left holding the bag.
My experiences have led me to approach any and all “tips” with a great deal of skepticism. Don’t get me wrong: I love tips. They are frequently useful, though not in the way you may think. Oftentimes, “tips” provide enormous insight into the public’s collective mind.
When someone gives me a tip that sounds as if it has a smidgen of merit, I will run it through my trade and research discipline. That process involves the following: First, I check out the chart. This eliminates MOST of the real dogs right away. If the chart indicates a stock in a long term, secular down-trend—game over.
If the chart does not immediately eliminate the stock, I’ll look at the fundamentals—the company’s financials, their business model, and their industry’s prospects . . . Sector strength is very important, so I’ll check out how their competitors’ stocks have been doing. A quick review of which firms have analytical coverage, along with their analysts’ long and short term perspectives of the company’s prospects may also provide some insight.
If no red flags have been raised yet, I’ll review the past six months headlines, stopping to read full stories which look interesting. I’ve also been finding that companies’ web sites occasionally provide insight; a slow loading, ugly-looking site is a very bad sign for technology, internet or telecom company. Lastly, I’ll order an investor relations package from the company.
That entire process takes anywhere from an hour to several weeks—I should really start charging for the service—so please understand if I don’t get all hot and bothered over your next great tip.
For those of you who still cannot wait to pass along the next hot tip, here is my list of Do’s and Don’ts:
Know the name, stock symbol and trading exchange of the company.
There are a million places to look this up on the internet. Try CBS Marketwatch , Hoovers , or Yahoo! Finance  for starters. Is it a NYSE  or Nasdaq  listed company? Lastly, if you don’t even know the symbol, how can anyone take ANYTHING else you say about a company seriously?
Perform a bare minimum amount of research.
What does the company do? Who are their competitors? How many shares are outstanding? What is their market cap? Smart Money.com  is a good place to find this information. When does the company report its next earnings? Check out Earnings.com  for starters; You can also find out the whisper number at EarningsWhispers.com .
Have an inkling of WHY you want to own THIS particular stock.
Have a defendable reason for owning shares in this company. What shred of wisdom or analysis do you have that thousands of analysts and fund managers have missed? Is there a catalyst that may move the stock upwards? That your Brother-in-law likes it is not a sufficient answer; The “fact” that “its supposed to go higher” does not qualify either.
Have a REAL price target in mind — one based on some rational thought process.
Where is the stock going to, and why? Just because your old college roommate or your FedEx guy said its going to $100, does not make it so.
Know what sort of timeline is involved.
What’s going to happen when? Is this a hold for a week, a month or a longer time period? How much patience do you have? Can you wait out some lil’ tidbit of news while the market gyrates to and fro?
Bring me INSIGHTFUL information.
(Not to be confused with INSIDE information) Insightful info is a unique perspective on a given company’s prospects that the rest of the world may not be hip to yet. Are you a supplier to XYZ corp, and they are ordering components like mad? Do you work for a recruiting firm and know that the company is adding employees as fast as they possibly can? Or conversely, are highly placed engineers or managers are fleeing? Did you just read a great article in a little known trade publication that the big boys haven’t caught onto yet? Has your firm just put together a multi-million dollar PR or ad campaign that you think is great?
Anything that gives you a unique insight into a company and its growth curve is potentially valuable. When I moved out of Manhattan some years ago, I discovered near my new home a 24-hour Home Depot. That’s right, a Home Depot opened around the clock. On a lark, I stopped in one night at 2 a.m. I was astonished to see they were jammed with shoppers — contractors, home-owners, people who work the graveyard shift — all roaming the aisles, orange carts laden with stuff. I bought the stock the very next day (split-adjusted price of about $8).
Know your sources.
Where is this info coming from? How reliable a source? Does this person have an agenda? I find many tips come from the same sources—there’s nothing wrong with monitoring tipster’s track records.
Lastly, ask yourself the following: Is this information that you really should not have? Is it coming from an insider, affiliate or major shareholder? If the source is TOO GOOD, you probably don’t want to trade upon it, for obvious reasons . . .
Don’t bother with something that you just heard on CNBC.
If its on CNBC, the entire world has already heard about it (Its worth considering going the opposite way, too). The idea is to anticipate which stocks WILL BE going up, not to buy stocks that have already had their runs. One of my reasons for calling a top in Qualcomm (QCOM) at 200 (800 pre-split) was the mere volume of people calling in to CNBC  to ask about it. Unless you are a trigger fingered day-trader, CNBC = Too Late. The same goes for the Wall Street Journal  or Business Week  or Investors Business Daily .
Don’t waste time with anything on the OTC: Bulletin Board.
The pink sheets, or penny stocks, as they are derisively known, are the last refuge of scoundrels and thieves. Despite an SEC crack down, many of these firms are several quarters (or years) behind in their filings. There are over 9,000 public companies that actually FILE their financial statements (and on a timely basis) with the SEC. Is there really any good why not to stick with this limited group of companies that are actually in compliance with SEC reporting regulations?
Don’t waste your time with AMEX stocks.
Though not as bad as the OTC:BB, they have their own problems. They are much less liquid, and transactions there are far less transparent than either the Big Board or NASDAQ. Think I’m being too harsh? Quick, name the last great AMEX stock you made money with? (I didn’t think so . . .)
Before you start writing: The derivatives on the AMEX—Spiders (S&P500), Diamonds (Dow Jones Industrials), QQQ (NASDAQ 100), and the various Merril Lynch Holders, such as HHH (Internet) and BBH (Biotech) are liquid enough that you can actually get a decent execution. But when was the last tip you got on any of these?
Same goes for Canadian stocks.
Usually the best thing to do when someone mentions a Canadian stock is to run screaming from the room as if you’re on fire. Don’t get me wrong, I love Canada—heck, I honeymooned in Quebec and Montreal; the people are nice, the food’s great, and the whole country is on sale for 33% off—but I suspect that the same people who run the Mississippi Riverboats are in charge of regulating the Toronto Stock Exchange. Other then the big, NYSE traded stocks — think Nortel (NT) or Shaw Communications (SJR) or others like them — steer clear.
Don’t even think about mining stocks.
A mine is nothing more than a hole in the ground with a liar standing next to it. The same goes for oil and gas companies that no one has ever heard of. Guess why no one has ever heard of them? If you said “Because they have no oil or gas reserves,” give yourself a star.
Don’t waste either of our time with stocks that don’t (or just barely) trade.
There has to be some liquidity, just so you can buy the thing at a fair price, and be sure there is an exit when the time comes. There are also technical reasons why you want to see some trading volume: The rule that “Volume Precedes Price” is a great truism.
If you have real “inside information,” don’t even think about calling me.
Call your lawyer instead; you’ll need ‘em.
Inside information are things that insiders and those with fiduciary relationships, such as bankers and accountants, know to be true, but have not yet been disclosed to the public.
There are 3 reasons not to trade on (or even tell me) these things: First, you could go to jail. (Not me; I don’t look good in orange, and I don’t think ANYONE looks good in prison issue jumpsuits). There’s a reason brokerage firm telephone lines are monitored and recorded — And no, its not "to insure quality service."
Second, its like cheating at cards: Where’s the fun or challenge in that? If you have to break the rules to win, then you shouldn’t be playing anyway.
Lastly, if you are not swayed by the "its just plain wrong" argument, consider the following logic: Its simply not worth the risk of huge penalties (including jail time) for a little bit of money; If you go for the big score, you will surely draw the wrong kind of attention from the SEC people who monitor these things. When you get caugth, they will make you yearn for those nice IRS folks from your last audit.
Finally, don’t confuse INSIDE information with INSIGHTFUL information, mentioned under the DO’s above . . .
Lastly, let me draw a distinction between “Trading Ideas” and “Stock Tips.” A trading idea involves a “known” stock and only requires a quick glance at a chart to make a buy or sell decision.
Lets take a look at two good trading ideas which came from my firm’s clients over the past year: Phillip Morris (MO) at $21, and Verity (VRTY) at $30.
Big MO has endured a terrible (and deserved) punishment at the hands of lawyers, government bureaucrats, and short sellers. Florida juries have been none too friendly to big tobacco, neither, threatening hundreds of billions of dollars in punitive damages. But all that news is already reflected in the share price, so when a client asked us about MO in the low $20s, we immediately recognized it as an idea with merit.
Any time a Dow component is off over 50% from its 52 week high, you must at least give it consideration. What other bad news could come out to further hurt the stock? As far as MO was concerned, I couldn’t think of any. We know that its product main product is addictive, that it causes cancer, and that the company markets its cancerous, addictive product to children. To top things off, its executive officers perjured themselves in front of Congress. All the bad news is already in the stock; What else could these guys do to hurt their themselves, short of cancelling Christmas?
On the positive side, MO’s food business is a terrific, recession-proof steady grower. The many brand names it owns—Kraft, Miller, Jell-O, Kool-Aid, Maxwell House, Oscar Meyer, Post—are probably worth more than $22 per share as a free standing business. On top of everything else, MO paid an impressive 9% dividend yield. We jumped in with both feet.
Verity was another client’s trading idea. A well known software and internet data mining firm, the stock got killed last year on an announcement of a contract delay. Merely pushing revenue forward from Q4 to Q1 should not have punished the stock this severely—driving it down from $57 to $27 in a day. After the bloodbath, the stock immediately started climbing out of the cellar enthusiastically—more than the expected dead cat bounce. At 31, it had a reasonable risk/reward ratio. Some clients took their profits a week later in the low 40s, but many held on for the ride: They bought a highly considered internet play at a hefty discount, and are comfortably ahead.
Article printed from The Big Picture: http://www.ritholtz.com/blog
URL to article: http://www.ritholtz.com/blog/2004/02/the-skeptics-guide-to-stock-tips/
URLs in this post:
 CBS Marketwatch: http://www.CBSmarketwatch.com
 Hoovers: http://www.Hoovers.com/
 Yahoo! Finance: http://finance.yahoo.com/
 NYSE: http://www.nyse.com
 Nasdaq: http://www.nasdaq.com
 Smart Money.com: http://www.smartmoney.com/stocks/
 Earnings.com: http://www.earnings.com/
 EarningsWhispers.com: http://www.earningswhispers.com/
 CNBC: http://moneycentral.msn.com/investor/home.asp
 Wall Street Journal: http://public.wsj.com/
 Business Week: http://www.businessweek.com/
 Investors Business Daily: http://www.investors.com/
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