Is It 1999 All Over Again?

The New York Times’ Bits blog has a post on Trefis, a Web 2.0 startup that apparently makes it easy for you to create your own valuation model for public companies. They give you starter models using public information, and you can then tweak the assumptions to come up with your own valuation. The pitch is that this puts the tools used by research analysts and professional investors in the hands of the retail investor. “Perhaps these new tools will put some added pressure on the sell-side professionals – many of whom are notorious for creating overly optimistic takes on the companies they follow.”

Or maybe they will make retail investors think they have an advantage that they really don’t. Advantages in stock valuation have to be based on superior information, which you can get by doing lots of market research (like some old-fashioned hedge funds do) or by having privileged access to company insiders. Superior information can include superior forecasting ability, so if you have some ability to predict the market size for routers better than anyone else, you can make money from it. But neither of these are things you get from models; they are things you plug into models. I’m sure the founders of Trefis don’t see it this way, but this feels to me like a great way to lure people into individual stock-picking, and thereby a boon to stock brokers everywhere.

Update: The post also links to an article about KaChing, which makes even less sense to me (except as a smart business idea that preys on people’s willingness to believe in the existence of stock-picking genius). According to the article, hundreds of thousands of investors manage virtual portfolios in KaChing, which effectively grades them according to risk-adjusted return and other criteria. Then you can subscribe to someone else’s portfolio, so that you make the same trades that she does (there is a monitoring mechanism to make sure that people are putting their money where their mouth is, according to the article), for which you pay an investment management fee to KaChing and presumably a brokerage fee to KaChing’s partner.

This is what confused me. Marc Andreesen, an investor in KaChing, said, “The concept is great — the ability to tap into not just the wisdom of the crowd, but to be able to identify and invest with the particular geniuses in the crowd that stand out.”

Market prices already reflect the wisdom of the crowd. If you create a small crowd and it doesn’t agree with the market, which crowd do you go with? As for particular geniuses, isn’t this just a clever way of marketing the coin-flipping phenomenon?

This is clearly why I will never make money investing in stocks.

By James Kwak

13 thoughts on “Is It 1999 All Over Again?

  1. Lose money fast!

    I think many people can’t tell the difference between speculative and real wealth. We have had over 15 years of bubbles. Most people under 35 have never, as adults, lived in an unbubbled economy. It’s become much harder to learn good financial management practices, and it was never easy.


  2. Full disclosure: I was involved with the beta for Trefis and know one of the founders but have no financial interest in it.

    You should play with the site some before you condemn it. It is a tool for doing exactly what you suggest: allowing investors to take personal forecasts about router sales, plug them into models, and see what their forecasts mean for the stock price.

    It seems at least equally likely to show people that their insight that “people really like the iPhone, I bet Apple is going to sell a lot of them” is already priced in as to show them their opinion about router sales would, if true, imply an underpricing in Cisco stock.

    Even if we grant your point that stock-picking is generally a long-term wealth destroying activity for individual investors, Trefis is at least a harm-reduction tool… and I don’t think abstinence-only education will work any better for stock-picking than it has for premarital sex.

  3. Don’t feel bad; the more one knows about markets the less comfortable one becomes playing in them with one’s own money. Of course the experts play with other people’s money, which is somewhat different.

    A leading expert on financial innovation is Satyajit Das. He recommends holding one month T bills. For those who prefer extended maturities, move out to 3 months.

    The only problem with the investment business is that important numbers on nearly all the financial statements are misleading except when they are entirely fictitious. You can only make money by anticipating the crowd, or at least jumping in after the crowd and making a timely exit. This is easiest to do in retrospect.

    It is now clear that the only recovery we can expect involves asset prices. The idea is to force everyone hiding in treasuries to move into stocks and push up asset prices enough to validate existing debts. Those who failed to get on board during the past six months are now kicking themselves and will soon be plunging in, giving those with gains time to cash out. What do you suppose will happen next?

  4. If I have data X about company A and I try to do my own naive analysis of that data with say, a calculator, a pencil and a piece of paper, I probably won’t draw a high quality conclusion.

    Enter Trefis. (Or hell, enter an Excel spreadsheet.)

    Now I take the same exact data and plug it into their analysis tools and it seems at least POSSIBLE (if not probable: I’m pretty sloppy with a pencil and paper) that I will draw a higher quality conclusion about whether to invest.

    In other words, it seems to me that I want to compare the conclusions I would make on my own to the conclusions I could make with the Trefis tools. The advantage I gain would be over myself.

    And there’s the analogy to people standing on their tippy toes while watching a parade. The first few people to do it have an advantage for about twelve seconds. Ultimately everyone does it and no one has an advantage. Now everyone HAS to do it.

    But, oh, those first twelve seconds!

  5. “This is clearly why I will never make money investing in stocks.”

    If by “investing” you mean “trading frequently,” you are correct. In fact, very few can consistently make money trading, and most of those are front-running.

    However, buying and holding individual stocks through a deep-discount broker ought to do at least as well as giving even a low % management fee annually to a fund manager, if you buy an assortment.

    Of course, if you can get by with the minuscule returns from bank deposit or Treasuries, more power to you. Most middle-class Americans who hope to spend 30 years retired cannot, particularly now that wages have begun to collapse.

  6. As Trae and Al point out, used properly Trefis could be a useful tool. Of course, the people who have the knowledge to use it properly could probably build their own spreadsheet just as quickly. It seems far more likely that Trefis and KaChing (the name alone says it all) will be making their money from the modern equivalent of the shoeshine boy who gave stock tips to Joe Kennedy.

  7. Are there rules/laws that prevent KaChing or Trefis from using usage data to front run? I know they can’t do it once the orders are actually placed, but the user’s intent is pretty clear before they actually click ‘place order now’…

  8. This is only my personal opinion, but I strongly believe individual investors CAN perform better than the funds and the indexes. As long as they choose at least 15+ stocks from different industries and pay attention to the fundamentals (Benjamin Graham style), over a 5+ year time frame they can “kick ass” on the experts. But that’s only my opinion, I have no graphs or formulas to prove that. But nonetheless I believe that very strongly in my mind… for whatever that’s worth. That includes Guru Kwak.

  9. I assert something weaker. I say that an individual investor, following your guidelines (or other equally sensible ones), could equal the performance of funds. But that ultimately is better, because he would not have to pay the annual management fee (only trade commissions, which if the strategy is buy-and-hold-a-long-time, will be low).

  10. Wow, talk about a subtle, and probably effective, creative move by TBTF financial wizards? This is how we make (we being them) lots more money. We prey on those gullible enough, and starved enough (having lost it all earlier in the year) to follow these supposed predictors and dive back into a market ruled by the big boys. Sorry, this is the Goldman-Sachs, etal stock market (as if it belonged to anyone else for several years now), and they will make the money, thank you very much. They make it by (as you said it) knowing the right people, the right timing, and by making it in the margins. If you can control enough trades, you can control the market. And the do, and they do. And they make it by being the premier power behind any new IPO’s, of course.

    They actually have their own hedge fund, and it’s called the United States of America. Now that they have been given unlimited financial power, they can plan when they want to move to, say, China, or India, and leave the rape victims behind perminently. Both countrie have lots of expensive homes, and lots of tie ups for huge yachts. Their lives are bliss and ours are a liquid that rhymes with bliss.

  11. Nice analysis. Giving a tool to the hands of people who do not have the knowledge of the usage or the information needed for the use is not going to help much, but as you pointed out, it will increase the activity of the retail investors.

    However, I guess you missed the point on the second topic.

    I agree, market price will reflect the collective wisdom of individuals. However, it does not have any historical information or the intelligence of the investors which set the price.

    What KaChing claims (I don’t know if it will work or not, I am just considering the claim alone) is that by creating the virtual portfolio’s and tracking the trades the members make, the portal will provide a mechanism to identify winning strategies and habits. People can get to know about the trades the successful portfolio owners make and adopt the same strategy if they like.

    This is more or less similar to what analysts do, except for the fact that KaChing provides better tracking of historical performance. It is based on the outcome of the past actions, not about the forecasts.

    Now, it makes several assumptions while concluding that it is going to attract people’s interest and help people. As we can see in the standard disclaimers, past performance does not guarantee continued performance. Also, it does not filer out random trades making huge profit, but there is no way anybody can repeat the same. I would have liked to see an evaluation of the performance of the strategies which are supported by strong technical and fundamental analysis rather than just trades. Only such an approach can help to separate the “wisdom” of smart thinkers from the “collective wisdom”.

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