Hot stock tips for 2012

No, that's not a typo. Amidst the silly season's 'hot tips for 2013' articles it is worth taking a moment to reflect on how pointless they are (possibly dangerous for those who act on them) and the fact that no-one ever goes back to check on how the 2012 tips performed.

I have just finished reading Nassim Nicolas Taleb's latest book 'Anti-fragile', in which he uses the concept of 'Postdictors' (those who say lots of, often inconsistent, things and, after the fact, claim those that work out well as predictions). The concept applies perfectly to 'Hot stock tips for 2013', statements by treasurers and economists (both of whom have turned postdicting into an art form) and financial commentators who over-use the expressions bullish and bearish.

The following quote from Taleb sums up the problem with postdicting (for those who follow the advice of those doing it):

....postdictors can cherry-pick and produce instances in which their opinions played out and discard mispredictions ino the bowels of history. It is like a free option - to them; we pay for it.

In Why you probably can't rely on a broker recommendation we highlighted the fact that the final recommendation of a broker isn't of much use to the average investor. Hot stock tip articles are worse. They have all the problems associated with broker recommendations plus a serious dose of 'postdicting'. Anyone whose prediction turns out well can crow about it. Those who missed out are safe in the knowledge that no-one will bother going back to check (or, alternatively, they can point to something else they said that turned out well).

The fact that the tip is being made for a calendar year brings another artificial constraint. If you were truly investing for the next year you'd be in cash and bonds, not shares.

With that in mind, let's look at how a couple of randomly* selected hot tips from 2012 performed - one an unnamed online Australian share service and the other the Forbes Top 10 (international stocks).

As most will be aware, 2012 was a good year for the market on average, but either sensational or ordinary for market tipsters, depending on whether they backed yield or growth.

It could be thought of as a tale of two passengers from Circular Quay to Manly. The first passenger - the one who bet on growth (for instance, resources stocks) - fell out of the boat, swam the rest of the way and ended up just making it to the beach. The second passenger - the one who took a conservative dividend approach (for instance, banks) - booked a safe indoors ticket on the Manly Ferry and ended up barefoot ski-ing at 150km/hr behind the RBA speedboat.

On average, these passengers made it to Manly at a good pace. But neither could honestly argue they achieved their objectives. The growth passenger nearly drowned and the conservative passenger, despite getting there quicker than they ever dreamed, battled to avoid their arms being ripped off.

Stock tips for 2012 followed a similar pattern. Tipsters who went for dividends, ended up with capital gains and can now hail themselves geniuses. But those who went for capital gains, ended up with none (and only a small amount of dividends).

This is reflected in the charts showing the performance of the two sets of hot tips. Chart 1 is the performance of the Forbes Top 10 (versus the S&P 500). Chart 2 is the Australian 'Hot stocks for 2012' (versus the ASX 200).

Chart 1

Chart 2

As you can see, the performance of each set of tips was all over the place, much like the performance of different components of the market.

What do these figures tell us? Nothing really (apart from what we already knew). Their overall performance is bad, but we don't know whether this is due to bad luck, unfortunate timing of the calendar year, or deliberate misinformation on behalf of the tipsters. Equally, those who predicted well may have had genuine insight or just gotten lucky.

Scarily, these same tipsters will be lining up again this year and somewhere out there investors will follow their predictions. This is the 'optionality' and 'cost' that Taleb refers to. The successful tipster makes money from whatever it is they are selling, the failed tipsters try again next year (without loss) and investors following the group of predictions make a net loss.

Anyone thinking about following a top stock tip article should keep this principle in mind. They should also remember that, unlike a broker's report, the brevity of these types of articles means they don't even contain any useful information. It would be quicker and less costly for everyone concerned if each of the tipsters just wrote a sentence or two on how awesome they are.

So, best to skip over all the 'hot tips for 2013' articles and move straight to the latest on the antics of Kim Kardashian. If reports are to be believed, there's at least a chance you might learn something from her on how to make money.

And what are the hot stock tips for 2013?

The same as every year: Buy shares when they're cheap, sell when they're expensive and skip all the hot stock tips articles.

* Those thrown up on the first page of a google search, with major Australian newspapers and major competitors to II disregarded.