Why Do We Bet On Winning Sports Teams But Buy Losing Stocks?
by Brian Livingston, Vice President, SIACharts.com
When I am first talking with advisors who are new to SIACharts and the concept of relative strength, to many of them the idea of buying stocks that have already had a substantial upwards move that quite often has exceeded the move by its peer group is considered to be outrageous and foolhardy. Why would you buy something that has already moved up when you could buy something that is trading at a cheaper price, has been beaten down and has not yet had the move that this other position has already done? It just makes sense that the beaten down stock is the better bargain and has the greatest chance of outperforming over the next period of time, right? So, as a result of this logical thinking advisors then go out and buy the bargains and explain to their client that it is trading at a discount and that things are looking good for the future.
Letâs now take that example and move over to the sports world and look at professional football (any sport would do for the example). Before the season starts âanalystsâ are trying to predict who is going to win the Superbowl. No games have been played yet, so everyone is looking at the roster, the health of the players, who they drafted in the off season, their schedule, last seasonâs record etc. Letâs consider this to be their fundamental analysis and this information may be beneficial in assisting you to make an informed choice for who may win until patterns start to emerge.
Then the season starts. After several games trends start to emerge as teams start to go on winning streaks and teams start to go on losing streaks. The losing teams can always start to turn things around, but it starts to get difficult and unlikely to do so. If we were betting on which teams were going to win games we would likely start betting on the winning teams and not the losing teams. The odds makers know this so they are taking into account the records of each team and it becomes more and more difficult for us to win our bet because the ârelatively strongerâ teams have to win by âxâ points over the ârelatively weakerâ teams in order for us to get paid on our bet.
As the season goes on, clearer trends start to appear as to who the strong teams are and who the weak teams are. At a certain point in the season, some teams admit to themselves that they are not going to make the playoffs, so they start selling off highly paid players to reduce salary or to build for the future, not unlike beaten down stocks that start to cut their dividend. Would you bet on a team that was starting to trade their best players? Would you bet on a team that was 1-11 versus a team that was 11-1, unless you were given a powerful incentive to do so? The answer in all likelihood is that you wouldnât expect the 1-11 team to win the game.
Now, letâs go back to the investing world and analyze how advisors have traditionally been taught to go about selecting stock for clients. If a stock is winning, or going up in value, advisors either sell the position if they own it or avoid it if they donât. Instead they take the money and go and buy the stock that is currently losing. Advisors are not even being given an incentive to do so, unlike in betting where at least we are given âpointsâ or a spread in our favor if we bet on the loser. Advisors are willingly âbettingâ on the losing team, something which they would not do in our sports example. And advisors are doing this over and over again, avoiding the strength and buying the weakness.
Another factor that advisors sometimes want to take into account is how long the stock has been strong for. There is a mistaken belief that since a stock or sector has been strong for a while, it should suddenly become weak so we should exit now or avoid it. But, if I asked people who followed football if they thought that the New England Patriots would make the playoffs again this year, most would likely answer YES even though they have already made the playoffs quite consistently for a number of years now (2001, 2003, 2004, 2005, 2006, 2007, 2009, 2010, 2011, 2012). We would likely continue to answer this way until we saw their performance weakening and not guess at it prior.
Essentially, advisors are doing the exact opposite of what they should be doing. They should be selling or avoiding their weakness and holding onto or buying the strength.
An example would be to take a closer look at the recent performance of Canadian Pacific Railway (TSE: CP). Canadian Pacific Railway entered the favored (buy) zone of the SIA S&P/TSX 60-Report on November 11, 2011 at a closing price of $62.70. Since this time, CP.TO has moved up the rankings to the #1 spot of the report about a year later on November 6, 2012 closing at a price of $92.87. At this point, CP.TO had already had about a +48% move and most people were selling their position because it was overbought and couldnât possibly go up any higher. But since reaching the #1 spot of the report, over the next 6 months CP.TO has gained another +35%.
Since entering the favored zone, CP.TO has gained approximately a 100% return in a year and a half and seen outperformance over the TSX Composite benchmark by 3000% which was up approx. 3.3% over the same time period.
At SIACharts with our proprietary relative strength analysis, we help advisors make better selections for their clients by following the simple concept that strength wins out over weakness which in turn has helped them to reduce risk and also increase their performance. We help advisors to stay with the winners and stay away from the losers. Come see how simple it really is at SIACharts today (sign up for a free two week by clicking here).
Everyone cheers for the underdog, but the smart money doesnât bet on them.
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