Apple Inc. (AAPL), Herbalife Ltd. (HLF): Why You Should Avoid Popular Stocks

The Law of Small Numbers

The nonsense doesn’t stop there. Consider the law of small numbers or the understanding that a larger sample of data gives a more accurate measure of performance than a smaller set. This is the reason why the number of patients goes up with later stage clinical trials. Pharmaceutical companies generate much more accurate data with later stage trials, and approval decisions are based on them and not on early stage data with a relatively small sample. With this in mind, why do investors trust fund managers on the back of their performance over one year or with a data point of one?

Two classic examples of this tendency are the hedge fund managers Andy Zaky and John Paulson. The former achieved fame and investment funds due to his analysis of one stock. No prizes for guessing it was Apple Inc. (NASDAQ:AAPL)! And no bonus for working out that Zaky went on to lose investors significant sums of money as outlined in this article. As for Paulson, he achieved fame and investment thanks to his outstanding performance during the recent financial crisis. While this deserves applause, it still does not represent a long term track record of performance; but that didn’t stop investors giving him huge sums of money. The result is that he has had a lousy couple of years, and Morgan Stanley is now reported as telling its clients to redeem their investments.

The Bottom Line

The moral of the story is to avoid highly popular story stocks or short term records with limited data to back up an investor’s performance. Investing is a hard grind and it requires a lot of hard work. It is easy for the investment industry to focus on high profile stocks and applaud and promote themselves on the back of a good year or two, but serious investors should not allow themselves to get seduced into investing with them.

The article Why You Should Avoid Popular Stocks originally appeared on Fool.com and is written by Lee Samaha.

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