Why you probably can't rely on a broker recommendation

As many of you will be aware, we have just finished the Intelligent Investor national tour. Firstly, let me say thank you to those who attended and those who came up to say hello. It was my first live experience of the Intelligent Investor community (although 'family' might be a better word) and you made me feel welcome. So thanks again.

During last night's Q&A session someone asked the question about whether you could rely on broker research. To paraphrase, the answer across the panel was 'they contain useful information, but we wouldn't rely on the conclusion'.

It occurred to me afterwards that what we didn't answer was the 'why' and it is possibly the most important part of the answer.

[Firstly, let me digress and disclose my conflict of interest due to my involvement with Intelligent Investor - to some degree a competitor to brokers - and hence the potentially self serving nature of this post. Although I can also say that I am only telling you what I have thought for many years.]

As an investor the critical question you always need to be asking yourself is 'what's my edge?' Your 'edge' is the advantage you have that enables you to beat the market. If you don't have an edge you need to get lucky, or the market will beat you.

Let's say you're a subscriber to Intelligent Investor Share Advisor. Presumably you've done your homework and decided Nathan and the team are intelligent, experienced, hardworking and independent. They've got a track record that enables you to work out what they've done in the past, what mistakes they've made, how they've had their success and what makes them tick. Not only that but, as you've paid for the service, you know you've got something the market doesn't have.

Assuming you're right - that the work Nathan and the team do for you is going to able to identify value - then they are your edge (or part of it).

[I will make the point here that these comments would apply equally to any other equivalent service you might use].

Let's turn back to the broker recommendation and the question is, again 'what edge does their recommendation give you'?

This is the problem. For most people, in most cases, you simply have no way of knowing.

You probably don't have much feel for the people doing the work, understanding of their processes, what their track record has been, what mistakes they've made, whether they've learnt from their mistakes or what's driven their past success. Critically, you also won't be able to tell what other influences are at work. There's not just the usual conflicts - corporate work from the company, mates with the CEO etc. There's also the subtle influences - is the firm making a big push into the industry in which the company operates? Does this make them favourably disposed to the industry even though they've got no obvious relationship with the company?

Some people will be in a position where they can do their due diligence and sort through all these issues. But most won't.

Worst of all, broker recommendations are a long way from exclusive. If enough people are acting on the recommendation then they are the market, they don't have an edge on it.

So make use of the research and analysis. There can be a lot of good stuff in there.

But unless you can answer the question 'Why does this recommendation give me an edge on the market?' then you can't rely on it.