Butting heads with brokers

By: Melanie C
Ever wondered why our recommendations often contradict those of your broker? Here's an explanation.

Imagine that you're strolling down a country lane. The birds are singing, the butterflies are floating on the breeze and all is right with the world. Then you come to a fork in the road and, being unfamiliar with these parts, you're unsure as to which path to follow. Left and right both seem equally attractive, so which path to take?

Thankfully, you're in luck. At the junction, perched on a shabby bench and a few worn rocks, sit five locals. You venture to ask their advice. Without exception, they tell you to head left, it being an easier and more scenic route.

So off you wander. The psychological principle of 'social proof', which says that humans tend to trust groups of people, has worked a treat.

But what if these individuals had been paid $50 to direct hapless travellers to a noisy market full of over-zealous touts determined to part you from your money? Would you still have taken their advice? No, but in the sharemarket, where some crowd members have a vested interest in influencing opinion, many investors do exactly that.

We're talking about brokers or, more particularly, broking research. At The Intelligent Investor, subscribers occasionally inform us that our view on a stock disagrees with their broker's research. We're invariably unconcerned by this, sometimes even heartened, and in this article we'll explain why.

Different incentives

As value investors, we only buy stocks that we believe to be trading at prices below their true worth. Companies frequently become underpriced when the crowd dislikes them (see our review of Grand Hotel Group on page 6), often as a result of operating problems which investors have blown out of proportion. In the past six months, our positive recommendations on Cochlear, Leighton and, most recently, Infomedia have fallen into this category.

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