Short-term Investor Behavior can be Exploited

Oct 1995 //
Investing
Patience

In any competitive endeavor it’s wise to study an opponent’s tendencies.  In football, a given team may tend to run left on third-and-short situations, and in baseball a given pitcher may resort to his fastball when behind on the count.  Similarly, it makes sense for us to know how other investors think and act.  For example, it’s common for some investors to almost automatically buy a company’s stock when the company reports earnings above expectations and to sell if earnings are below expectations.  (These are the so-called “momentum” investors.)  While I doubt that this is the secret to long-term success, I do look for ways to exploit the short-term swings induced by momentum investing.  Since short-term earnings expectations tend to be reasonably accurate (albeit sometimes rosy), even the best of companies will occasionally report slightly lower earnings than expected.  When they do, it’s not uncommon for their stocks to be hammered temporarily.  Of course, that’s when I might step in and buy—because long-term results are driven by long-term company performance, not what happens at the margin in any given quarter.