The Two Primary Schools of Investing

Fundamentally, I think there are two main schools of investing. 

There are the guys who believe in doing rigorous research and finding stocks that are undervalued.  These stocks could be undervalued because of their cheap price or because they will benefit from trends that are not reflected in their stock price.  Essentially, this group tries fo find stocks that they believe the market is mispricing based on the facts. 

On the opposite spectrum, there are the guys who don’t concern themselves too much with the underlying facts.  Their concern is with what is working, what’s going up and what isn’t.  They want to own what’s going up and avoid what’s going down.  By necessity then, these guys make their investments based on perception, sentiment and psychology. 

As I discuss in my essay “My Investment Philosophy”, all of these factors move stock prices and should therefore be taken into consideration.  But, for the most part, investors tend to fall into one or the other camp.  Some guys are mostly concerned with facts while others are mostly concerned with psychology. 

Daily Wealth today posted an excerpt from Barton Bigg’s Hedgehogging providing an excellent example of an investor subscribing to the momentum, what I’m calling psychology oriented, school of investing:

[Dave] lets the market tell him what groups and stocks to own rather than trying to tell the market what groups should do well.  In other words, he looks for sustained relative strength.  If a stock or group of stocks are going up faster than the market, he will instruct his analysts to investigate them.  Unless there is something seriously wrong with the fundamentals, he will buy them, and he will hold them until they start to lose relative strength.  He will never buy a stock just because it is cheap.  He will never try to be a bottom picker.  He thinks that investors who buy underowned, unloved, and undervalued stocks are crazy.  Buy and own stocks that are going up; sell and avoid stocks that are going down or sideways. 

For example, he had a big position in Nortel, which he had bought at a price of around 16.  I visited Nortel in April 200, and you didn’t  have to be Benjamin Graham to figure out that this was an accident waiting to happen.  The stock was selling at a hundred times exaggerated earnings.  Its accounting was a farce.  Instead of doing research and product development, the company was paying ridiculous prices to acquire tech startups.  The executive vice president spun me a bunch of baloney about ‘the innovator’s dilemma and disruptive technologies’.  He told me how ‘Nortel had a virtuous circle going’.  It was crazy!

I came back to New York and called Dave when Nortel was at 62.  He listened carefully and said, ‘You may well be right, but I am going to wait for the market to tell me.’  The stock kept going up and hit 75 in May.  Then, that fall, with tech beginning to get hit hard and the stock at 60, one morning Nortel announced that fourth quarter earnings were going to be down substantially, and that its order backlog was declining.  Nortel opened late that morning, down 12 at 48.  Dave sold his whole position that day.  Over the next two years the stock went to 3.