I recently came across an interesting academic research study called: Information Diffusion Effects in Individual Investors’ Common Stock: Purchases Covet Thy Neighbors’ Investment Choices by researchers at the University of Illinois.
In spite of the dead boring name the study is very valuable as I have recognised the results in my life and I am sure you will too.
Your neighbours influence your investing
The study found that the stock purchases by neighbours have a large impact on the stock bought by investors.
For example the researchers found a 10 percent increase in neighbors? purchases of stock in a particular industry was associated with a 2 percent increase in stock purchases in the same industry by those living nearby.
Other findings by the study were:
- That investors were more likely to invest in a companies head quartered within 50 miles of where they live.
- Also investors more readily followed the investment choices of their neighbours if they lived in large metropolitan areas.
I have seen the findings of the study play out in my life.
You meet friends at a party or dinner and someone mentions an investment that has done well. Or someone mentions that at the company she works for, has so many orders that everyone is working day and night and she is buying as many shares as possible.
I, and I am sure you, are immediately interested.
Even though I avoid stock tips like the plague I still get sucked into them against my will sometimes. I think its an inborn human trait to fall under the spell of stories.
It is easier to be swayed by a good story than an analytically look at the facts. Something like a moth to a flame.
I had such a story stock in my portfolio recently and it was not a pleasant experience.
This is what happened:
- A bit more than a year ago I met the CEO of a small listed company at the birthday party of a friend.
- I took a look at the company and saw that it was relatively undervalued and I asked the CEO about it the next time we had contact
- He mentioned that all was going well, stating the information from the recent regulatory news filings (no insider stuff)
- He told a great story and I was sucked in
- I looked at the company again and invested
- The shares fell with a market decline and continued falling against the market, getting cheaper and cheaper. Going down to a price to earnings ratio of less than two.
- I remember the CEO’s words and ignored my normal hard stop loss at a 25% loss.
- Then came the news that a subsidiary has been put into liquidation and an investigation has been launched
- Now I was really kicking myself as my loss was at 78% after a sharp drop in price
- I sold all the shares after a bounce off the all time low.
I am now even more allergic against stock tips from anyone. Even more so if there is a story attached to the idea.
The only positive development, apart from learning this lesson again, is that previous experience has taught me to invest less than half of my normal position in story stocks.
Al least what I have learned before has paid some dividends, helping to limit my losses.
Learn from my mistakes
Learn from my mistakes and treat investment tips and story investment ideas like any normal investment that must go through your normal analysis routine. And do not forget stop losses should you use them.
Your trying to ignore story companies analyst
PS A great tool to find your own investment ideas is the Quant Investing stock screener.
PPS Why not take a look right now?