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Chapter 13. Follow the Experts > Lessons for Investors

Lessons for Investors

If you decide to follow the experts, the evidence presented in this chapter provides some pointers on how you can improve your odds of success:

  • Pick your experts well. Some insiders are more inside than others, and some analysts are more credible than others. The key to an expert-based strategy is to separate the true experts from the charlatans. In the case of insiders, this may mean tracking some insiders (CEOs and directors) more closely than others. With analysts, you may want to look at their history when it comes to revisions and recommendations. Earnings revisions by analysts who have a history of forecasting earnings accurately should be weighted more than analysts who do not have this reputation.

  • Screen for bias. Analysts often have multiple objectives, and a buy recommendation from an analyst may sometimes have more to do with maintaining access and investment banking deals than with whether the stock is a good buy. There are two possible screens for bias. One is to consider only analysts who work for entities that have no business relationship with the companies they analyze. The other is to look at the track record of the analyst. Analysts who have a history of standing up to company management and issuing sell recommendations have more credibility than analysts who always seem to find only good things to say about the companies they analyze.

  • Look for clues of forthcoming activity. With both insider trading and analyst recommendations, a large portion of the price runup precedes the actual news (insider filing with the SEC or analyst changing a recommendation). While there are no foolproof early warning systems, you can look at trading volume to get a measure of upcoming news. Trading volume will often jump as a result of insider trading, especially in lightly traded companies.

  • Track closely. It goes without saying that you should be in possession of insider trading information or analyst recommendations as soon as feasible. This may require an investment in better information systems. For instance, there are paid services that cull through SEC insider filings as soon they are made and provide quick summaries to clients within a few minutes.

  • Trade quickly. Once you find out insiders have been buying a stock or that a top analyst has upgraded a stock, you will need to trade quickly. If you want to do other analyses—check pricing multiples or do a discounted cash flow valuation—you should have done this before the fact. For instance, if you want to buy only stocks that trade at less than 20 times earnings, you should screen for those stocks first and prepare a list of companies that meet this criterion. If there is news about insider buying or analyst upgrades with these stocks, you can immediately add them to your portfolios.



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