What's Different About Extreme Value

I got to talking with the shuttle driver. Let's call him Joe. Joe's been working at the car dealership for about eight years. Joe says he thought he'd be retired by now, but the stock market let him down. He told me what he does with his money...

Simply put, Joe is hypnotized by the tape. He reads the paper and various investment websites, watches a lot of CNBC, and makes lists of stocks that are mentioned. "I've got eight or 10 lists of stocks, with 50 stocks each."

I couldn't help asking Joe, "What do you do with these lists?"

JOE: "I watch 'em."

ME: "What do you watch for, Joe?"

JOE: "I just wait to see how they do."

ME: "You mean, you wait to see if the stock price goes up or not?"

JOE: "Yeah. I've got some stocks on my lists that have gone up 500% in just a few weeks. Some have fallen in half, though, too."

ME: "Which ones do you buy?"

JOE: "Well, I buy the ones that go up... 'Course, you gotta be careful cause sometimes they don't go up anymore... I got one that's down 70%, but I'm just going hold on to it and wait for it to come back now... I like to read my lists at night before I got to bed, just to see if anything jumps out at me..."

Before we parted, Joe handed me a slip of paper with a stock symbol on it, a pink-sheet stock that's building social-networking websites. Super speculative. No profits. Destined for the scrap heap as far as I can tell.

Throughout the conversation, I barely got a word in edgewise. Joe was excited and eager to share his secrets about making lists of stocks to watch. And he knew our conversation would end when we arrived back at the dealership, so he was talking like an auctioneer selling ice sculptures in Arizona.

Either way, he had so little to say and so many ways to say it that I was only able to tell him once that his "strategy" was never going to work because he didn't know what he was buying and didn't hold anything long enough to make real money. Joe would do much better if he simply bought every name on his lists, forgot about them for 10 years, and got a hobby.

Joe did one bit of work that might actually justify his aimless list making. He has a list of every stock that's ever been touted to him by regular mail and e-mail. He says almost every single one of them falls precipitously after it goes on his list. I thought he was going to tell me he'd made a fortune shorting them, but no. He doesn't short them. Just another list to... er... watch.

Unfortunately, I have a feeling Joe's story is an example of how many people treat real money. They sit mesmerized by the news and the tape. It's all price quotes and sound bites – a completely passive orientation toward what to do with real money. Who knows how they actually decide what to buy? I figure intestinal gas is taken as a buy signal much of the time.

Joe is like a deepsea diver who has mistaken water skis for scuba tanks and now he's trying to find sunken treasure while riding on the crests of waves. He doesn't notice his enormous mistake, because it feels good to be skipping along on top. People are hauling up treasure all around him, so he knows he's in the right place.

Bad news for Joe and his ilk is good news for people who invest in cheap value stocks.

The fact that anyone with $2,000 can open an online account means that more people than ever are managing their own money. And that virtually guarantees that we'll always be able to get an advantage in the market by doing deeper research, holding a more focused portfolio, and always, always, always holding for the long term.

I used to feel sorry for Joe. Now I think feeling sorry for folks like him is a mistake. They're adults. Adults have an obligation to be rational. If you're not rational, you run the risk of becoming road kill.

Call it evolution, then. People who avoid their homework and chase hundreds of hot stocks go the way of the dodo bird. Extreme Value investors are cockroaches. They're doomed, we're indestructible.

Good investing,

Dan