Over the weekend, Jason Zweig, one of my favorite financial journalists, wrote an excellent piece in the Wall Street Journal which tries to explain with so many individual investors tend to find comfort going with the crowd. He cites a scientific study that found “the value you place on something is likely to go up when other people tell you it is worth more than you thought, down when others say it is worth less.” He places this study’s findings in the context of investing by concluding, “… investors often go with the crowd because – at the most basic biological level – conformity feels good.”
I always find some comfort when I discover that my opinions match up with someone whom I respect (hey, conformity does feel good!), but most of the time, I find myself at the periphery of consensus, toiling away in the dark shadows of non-conformity. In this article, Mr. Zweig praises the notion of contrarian investing, but highlights why most people have trouble doing it — because it usually always feels “wrong.”
At the various Wall Street shops where I worked, I saw this “comfort in conformity” idea played out over and over again. Whenever an analyst would upgrade a rating on a stock, if several people on the sales desk would get excited about this move, it would take very little time for the entire group to be enthusiastically recommending the stock. At other times, if a senior person on the desk would have reservations about the ratings change, the reaction from the desk would be likewise tepid.
On the Buy Side too, we see this phenomenon at work. Quick scans of top holdings of mutual funds which focus on the same investment style will often reveal a certain degree of conformity. When I was a portfolio manager, I recall hearing my colleagues offer such gems of wisdom such as “no one will ever fault you for owning P&G” (or other big, blue-chip names). Everyone does it, so it must be good, right??
Even now, I must admit that when I am analyzing a stock, if I find that it is currently owned by Berkowitz or Buffett, I find myself regarding the stock with more confidence than I would have otherwise. So even the contrarian can find some comfort in conformity from time to time.
Yet, moving with the herd is rarely the best way to invest. Benjamin Graham, the founder of value investing, noted that “the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities. The market is a voting machine whereon countless individuals register choices which are the product partly of reason and partly emotion.”
Zweig offers this sage advice to those wanting to dabble in the realms of contrarianism, “…you should note which way the herd is moving – and go the other way. You should get interested in a stock when its price gets trampled flat by investors stampeding out of it.”
Well said. See you in the shadows…
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