Portfolio Madness: Don’t Pick Stocks The Same Way You Pick Your Bracket
For basketball fans like me, it’s a wonderful time of the year. March Madness brings 67 thrilling games spanning three weekends in March and April, getting together with friends and family to watch upsets unfold and bantering about who made the best predictions in their bracket pool. It’s hard to think of a more exciting time for basketball fans.
When it comes to investing, there’s plenty you can learn from your March Madness bracket about picking stocks—more specifically, what not to do. In other words, it’s probably not wise to pick your investments the same way you fill out your bracket.
Sticking with What You Know/Not Doing Your Research
If you know anything about college basketball, you likely know there is a list of schools that are expected to be successful year in and year out, and they often end up being popular picks in March Madness brackets. Duke, North Carolina, Kansas, and Kentucky are a few of these teams for example. Some people prefer to pick a “safe team” to win the whole thing without doing any research. Well, did you know that North Carolina might miss the tournament entirely? Or did you know that Kansas and Kentucky have not been as dominant this season as in past years?
When no research is done, you’re living off the hope of past performances. I would not recommend investing in a company just because you know their name. The power of a brand can make for a strong economic moat, but it doesn't always translate to capital appreciation for their stock.
Let’s take Walmart for example. Everyone knows what Walmart is, and millions of people shop there. Is that a good enough reason to invest lots of money into Walmart’s stock? No, probably not. Instead, you should be asking: How has their stock historically performed, and can this pattern be expected to continue? What is the value of their stock? Is their stock trading for a price close to its relative value? Does Walmart’s stock pay dividends?
Now, this is not to say that Walmart is a good or bad investment, but I do want to emphasize how important researching a company is before you buy their stock. Of course, anything can happen in the stock market, much like in March Madness, but your portfolio is likely to perform better when solid research has been done.
Rooting for the Underdog
Rooting for the underdog to go on a Cinderella run is exciting; it’s something most people can rally behind. How could anyone forget a few years ago when one of the greatest upsets of all time took place?
Stick with me, Purdue fans! An underdog story can be fun to follow, but it’s one that usually occurs with a little bit of luck. If you’re one of those people who picked Fairleigh Dickinson to upset Purdue two years ago, let’s be honest: You won that pick out of pure speculation.
Investing with speculation as your motivating factor doesn’t usually end well. Speculation seems to occur when new companies, or even new industries, start to arise. Let’s pretend a new sports drink company launches an IPO to compete with Gatorade, Powerade, and Body Armor. They have announced a partnership with your favorite actor, who does plenty of commercials for them, and they are making flavors that the other brands I listed do not currently produce.
Again, I ask, are these reasons good enough to invest in the new company? Let’s counter those reasons with research questions: What do their earnings look like? Is there any evidence that they are outperforming their competitors? Is their IPO launching at a fair value? Not to beat a dead horse, but research is essential to selecting investments that will help you accomplish your goals.
Bias Towards the Hometown Team
My last point is about the inherent bias people have towards their favorite team. When fans of Purdue, IU, and Butler see their team make the tournament, they are likely to select them to win a few games in their bracket. It’s natural to think your team will succeed because you want them to succeed. This concept isn’t unique to the basketball fans in our great state, and it certainly isn’t unique to the sport of basketball.
Many investors have this same bias towards companies or industries they like. Whether Coca Cola is your favorite beverage company or if Nike is your favorite clothing brand, liking those companies and wanting them to succeed financially doesn’t mean they will. Similarly, many investors tend to show bias toward companies in their city, state, or country. An energy company headquartered in Ohio might be an appealing investment to Ohio residents, but one of their competitors headquartered in Oregon might be an even better investment. A similar company in Sweden might provide yet a better opportunity than these two American companies. A company’s stock won’t always perform better just because you like the company or because they’re located in your backyard. Making an informed decision remains key.
The Bottom Line
When it comes to picking victories in your March Madness bracket, bias and speculation are often motivating factors for the selections you make. Picking which companies to invest in should not be done in this manner. Doing ample amounts of research in order to make informed decisions about investing is the best way to go.
If researching stocks isn’t your thing, or if you do not want to take the time this research may require, reach out to a member of the Aurora team for help with curating a portfolio. We’d be happy to help you make investment selections that align with your financial goals.