Novice investors either expect the stock market to be efficient, according to Efficient Market Theory where all information is known by all investors, or they expect to invest based on hunches or even inside information. However, experienced investors know to study the specialized analysts, and make rational decisions supported by careful analysis, but always expect some irrational behavior.
For example, consider the example of IBM, a historic giant in information technology. Morningstar gives it 4-stars, with a grade of A on financial position. Thomson Reuters rates it a BUY, with its highest possible score of 10. Standard & Poor's also rates it a BUY, as does Argus and The Street. The Jaywalk score of 2.65 makes IBM a BUY.
Yesterday, the company announced an increase in its profit margin and got pounded by the market, losing a whopping 4% in one day. Because the company is such a large component of the Dow Jones Industrial Average, the Dow was down most of the day, even though the S&P 500 was up strongly. How's that for irrational behavior? Since when is increasing your profit margin bad??
Here's the problem: total revenue was down slightly because of a 40% drop in hardware sales in China. Following the Snowden/NSA affair, the Chinese government has become worried about sales of American technology in their country and is pressuring Chinese businesses to only buy Chinese technology. That's it! A clear market over-reaction, making IBM an even better buy right now, I think.
Most pundits think it was Lord John Maynard Keynes who first warned that the stock market can remain irrational longer than you can remain solvent. In other words, always expect some irrationality but don't fight it. Adjust your investment decisions when irrationality presents opportunities.
Rational investors don't need to understand irrationality . . . just deal with it!
For example, consider the example of IBM, a historic giant in information technology. Morningstar gives it 4-stars, with a grade of A on financial position. Thomson Reuters rates it a BUY, with its highest possible score of 10. Standard & Poor's also rates it a BUY, as does Argus and The Street. The Jaywalk score of 2.65 makes IBM a BUY.
Yesterday, the company announced an increase in its profit margin and got pounded by the market, losing a whopping 4% in one day. Because the company is such a large component of the Dow Jones Industrial Average, the Dow was down most of the day, even though the S&P 500 was up strongly. How's that for irrational behavior? Since when is increasing your profit margin bad??
Here's the problem: total revenue was down slightly because of a 40% drop in hardware sales in China. Following the Snowden/NSA affair, the Chinese government has become worried about sales of American technology in their country and is pressuring Chinese businesses to only buy Chinese technology. That's it! A clear market over-reaction, making IBM an even better buy right now, I think.
Most pundits think it was Lord John Maynard Keynes who first warned that the stock market can remain irrational longer than you can remain solvent. In other words, always expect some irrationality but don't fight it. Adjust your investment decisions when irrationality presents opportunities.
Rational investors don't need to understand irrationality . . . just deal with it!
