Information – The Most Important Thing in Investing

I always tell my finance students and my assistants that the most important thing in investment is information. Even the more modern theories and studies of markets and investment have focused on that, for example, in efficient market hypotheses (EMH) and post earnings announcement drift (PEAD). In that regard, the EMH’s, in all of their forms, say that stock or investment asset prices should reflect all of the available information about the investment, including estimates and anticipation of future events. PEAD shows that prices react slowly to information, even long after a surprise announcement, because people are slow to assimilate the information, which may be part of the general principle that people are slow to recognize or accept change.

In one of the forms of the EMH, it says that investment asset prices reflect all of (depending on the definition) information, including estimates and forecasts of the future. In that regard, one cannot expect to make any kind of exceptional returns. In reality, not all of the information that can be available is available to the general public or, as PEAD seems to indicate, even when it is available, not everyone assimilates it properly. Thus, the way that a person can make better returns is to get and assimilate more information and more quickly than others.

In my second career on Wall Street, I was a merger arbitrageur, investing in the stocks of companies being taken over by other companies. At the time, many people believed that that business was run on inside information. The truth is that it was run on information that was simply not in the public domain, analysis that was beyond the reach of the general public, and hard work. As a simple example of hard work, when a bank merger was announced, I would go to the Federal Reserve Board publications and use Hirschman-Herfindal antitrust analysis to compare overlapping bank branches of the two banks, so I would know any potential anti-trust issues. Then, I would wait to see if the banks admitted that they had these problems and had a plan to resolve them. I also hired an antitrust lawyer to review all of the proposed mergers or takeovers for potential antitrust problems. I also hired lawyers who specialized in other areas, like securities and takeover law and FCC law. Those expert opinions gave me information that was not available to the general public and their cost was beyond the reach of the man-on-the-street. In addition, I would attend any hearings, in courts, in Congress, or at regulatory agencies, to get first hand information, including the tone, face and body language of participants. Moreover, by analyzing every merger that came along, I became an expert in all aspects of takeovers, and investment bankers and heads of major corporations would come to me for advice. In some cases, my knowledge and opinions even helped to change laws and regulations.

One must, also, be careful of information. There is the concept of disinformation, which can be useful, if you are the disseminator of it. However, many people take some things as real information that are not real information. For example, when I created an internationally recognized country inn, in the 1990′s, I put profiles about the inn in various tourist guides for the area, and people would tell me what the tourist guide said about the inn. They mistook my own self-serving press, which I actually paid to have printed, as opinions of the travel guides. Often, too, I would find press releases, which I had written, turn up, unedited, in newspapers and magazines. Most people believe what they read in the news and question nothing. I question everything. If, for example, someone says something is the best, I want to know who the person is, what their qualifications are and their opinion of second, third and last best, and I want to know why.

In general securities trading, there are professionals who know the real information, and there is a lot of public information on the well-followed stocks. Some of that “information” comes from brokers, other sales people, and securities analysts. Most people take those things as good information or tips. However, even securities analysts are in the sales department of securities companies, and their recommendations generate riskless brokerage commissions for the company. My first job on Wall Street was as an analyst, and even though, coming from a physics background and having an MBA, in finance, from one of the top business schools, in the world, I demonstrated creative ability to analyze economics, industries, and securities, the head of the department did not like me because he though that I was not a good enough sales personality. Indeed, my ability to analyze did not matter to him, at all. Not only do some securities analysts not analyze stocks, they also tend to “hug the benchmark” and keep their estimates and opinions in line with the industry average, for fear of losing their jobs, if one of their opinions were both atypical and wrong. Thus, most of the things that you will hear from brokers, salesmen, and analysts is just self-serving bravado meant to drum up sales commissions.

Those facts, coupled with the fact that there is so much information about many stocks, in the public awareness, has created another opportunity to mine information: under-followed and small-capitalization stocks. As a result, some investment analysts and advisors have looked for and analyzed stocks that are not in the public awareness and are not followed by the major securities firms. Indeed, even those techniques have been exposed to the general public, having been found as so-called “anomalies” by academic researchers in finance (they are always the slowest to catch on).

Another technique heralded by David Dreman is called “contrarian investment strategy” (see our recent article about that on Articles Base). The theory, there, is that, in part, due to the lack of real analysis by analysts, and, partly, due to overreaction, in general, stocks that have already been beaten down deserve another look and can offer another form of real opportunity. Such stock will tend to have low PE ratios and offer the prospect for PE arbitrage. Again, it is simply a strategy of looking for value in places where other people are not focusing their attention, and there results an information deficiency.

Although the news industry has always had its lazy people who just reprint other people’s press releases, the industry has become even more unreliable, over the last decade or so. Because of competition from many other sources, open round the clock, often, we have observed, reporters are in such a rush to beat their competition with breaking news that they do not thoroughly or carefully check and verify the information. Indeed, part of that is due to manipulation, but the press should be on guard about that, in the first place. In 2001, I returned, briefly, to the arbitrage business. The reason my stay was so brief was that there was so much misinformation in the business press and on business television. Sometimes, I made money because I knew something from the press was not true, and I would just trade against those who bid up or knocked down stocks based on the misinformation. Other times, it cost me, dearly, because I had a position, and someone fed the press misinformation, which they, in turn, told to the world without checking their facts. It is my observation that short sellers regularly try to get members of the press to print stories

That is the reason the current focus at our company is on art. Art markets have always been more inefficient than securities markets (you can download reports from the In County Analysis page of our website about art markets, and we have written other things in blogs about art investment). The information is more difficult to come by, and that makes it more valuable. Although price information can, for example, be found from art auction records, auctions are infrequent, not all day, daily, as with securities and commodities, and auction sales do not account for all art sales: most are done by art brokers and dealers. Even the art, itself, is more difficult to acquire, and it is one of a kind, not just one share out of several million, like stocks or bonds. In that regard, even information about the location or availability of a piece of art can be valuable, as can be direct relationships with artists.

So, the next time you hear a “hot tip” from your broker, listen to a pitch about easy returns that seem too good to be true, or even read something in the press, do not just believe it, question it. Real information is a valuable thing, and it is seldom cheap or easy to come by. And it is the most important thing in investment!

© 2009 Craig L Mattoli, Red Hill Capital Corp., Delaware, USA