Fred Stanske uses the insights of Nobel winner Richard Thaler, the ‘father of behavioral finance,’ to beat the market with under-the-radar stocks. Here’s how he does it, and 2 picks he’s buying for long-term gains.

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Richard Thaler

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One of the observations that won behavioral economist Richard Thaler a Nobel Prize is, in essence, that investors tend to keep their friends close — but their enemies closer.

That is, they habitually sell the winners in their portfolios while refusing to sell the losers. Thaler’s technical name for that habit is the “disposition effect.” But Fred Stanske, a portfolio manager at $9.3 billion Fuller & Thaler Asset Management, says the Nobel laureate has a catchier nickname for it: “Get-even-itis.”

“When someone gets a piece of positive news in a stock and it goes up, they usually have the inclination to sell that stock versus holding on for future goods news, and correspondingly, if they get bad news and the stock goes down, they continue to hold it hoping it will come back  and they’ll get even,” Stanske said in an exclusive interview.

Stanske has worked at Fuller & Thaler since 1996. He runs its Behavioral Small-Cap Growth Fund, which seeks profits in Wall Street’s mistakes and biases. Small-company stocks are having a notably bad time in 2020, but Stanske’s fund has returned 21.9% to investors as of September 2, well ahead of major indexes and most small-cap growth funds.

How they find stock picks

Fuller & Thaler’s funds target stocks that are either underreacting to good news or overreacting to bad news. Stanske’s fund is in the first category. Instead of looking for stocks that are about to move higher, he wants companies that are already rising because of developments like strong earnings or new products, but have much further to go.

“We’re actually buying the news of the positive information and we’re actually selling it when the analysts or the market participants have caught up to that new at new earnings stream or that new information about the company,” he said.

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The key to that is finding stocks where analysts are too slow to update their estimates and views once that good news arrives. That makes them, in the firm’s language, “biased forecasters,” and it can be a sign of opportunity in the stock. If expectations are stubbornly low, the company should beat them repeatedly, leading to long-term gains.

“The next quarter, you’re going to see a positive earnings surprise, or sales surprise. And this will go on for a number of quarters until the analysts actually catch up.”

It’s only at that time, typically after a year and a half to two years, that he’ll sell the stock.

Dealing with their own biases

While the Fuller & Thaler managers makes money based on the biases of others, they don’t pretend to be free of them either. Instead, they aim to be aware of them and take them into account, and he urges investors to do the same.

“I think the most important thing that everyone should know is that the behavioral biases are hardwired into us as human beings,” he said. “We’re all overconfident to a great degree … market participants are very overconfident in their opinions on companies.”

The firm takes some surprising steps to keep …read more

Source:: Business Insider

      

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