Despite what some skeptics say, the people who make stock picks on cable TV usually give you their honest opinions. The problem is that most of the stocks they pick are far too risky.
Recently a Member of my Inner Circle asked a question that many investors have wondered about over the years.
“Why is it that recommendations from the various pundits, CEOs, brokers, and money managers so often go down rather than up after they tout their stuff on [a Canadian cable-TV financial channel]? Are these guys above pumping and dumping?”
“Pumping and dumping” is far too strong a term. After all, that’s a form of stock fraud.
Pump-and-dump operators usually focus on small and little-known stocks with few if any tangible assets. Perpetrators of the scheme already have a holding in the company’s stock. They plan to “pump” demand for their shares by circulating false, misleading, or greatly exaggerated statements and predictions about the stock. They plan to “dump” their holdings after their hype has led to a rise in the stock’s price.
The stock usually collapses within a few weeks or months. Though this practice is illegal, successful prosecutions are rare.
The wrong kind of stocks
In contrast, cable-TV guests and broadcasters operate well within the bounds of the law, usually with honest intentions. They want viewers who act on their advice to make money. In most cases, the guests and/or their clients already own the stocks they recommend.
Sometime after guests appear on the program, they will undoubtedly decide to sell. (They’ll refrain from selling immediately after their latest televised recommendation, to avoid the appearance of selling into demand stirred up by their recommendations.) But the risk of following their advice has more to do with the kindof stocks they recommend, rather than their reasons for recommending them.
Lots of cable-TV commentators focus on small-cap stocks. These stocks are more volatile and less widely traded than the well-established companies we favor at TSI, so they can put on more impressive gains in a short time. Of course, this volatility works two ways.
Volatility works both ways
If they run into a business setback, small-cap stocks often go into a deep slump. Recovery can take a long time, if it happens at all. In addition, these stocks may have already made big gains before you hear about them. The price you pay may be high in relation to a conservative assessment of their long-term value.
To sum up, if you buy stocks based on tips from cable-TV commentators, you face an above-average risk of buying thinly traded, low-quality junior issues that have already gone through an undeserved rise, and are likely to slump deeply and stay down if they run into a business setback. That’s not a guarantee of poor results, of course. But it tilts the odds against you, regardless of the intentions of the advisor.
Courtesy Fundata Canada Inc.© 2015. Patrick McKeoughis a professional investment analyst and portfolio manager. He is the host of TSINetwork.com, where this article first appeared. Investments mentioned are not guaranteed and carry risk of loss.
