Mathematician John Allen Paulos, in his most recent book (A Mathematician Plays the Stock Market, Basic Books, 2003) coined a term which I had hoped would catch on throughout the finance community. He describes under-researched puff pieces on personal finance (e.g. Five Hot Stocks to Pump Up your 401k NOW!) as “financial pornography.”
One of the biggest purveyors of financial pornography online is the MSN.com website, and this column doesn’t disappoint: Seven Signs a Stock is Ready to Soar. The author purports to explain how to locate ‘hot’ stocks, those that are about to appreciate rapidly in price, by reviewing some research on what types of conditions most often preceded (notice I did not say caused, and neither did the research) a price increase.
It should not take a Wharton MBA to figure out what is wrong with the premise of the article. The cited research identifies the seven conditions that most often preceded a big run-up in the price of a particular stock, but nowhere does it suggest that these conditions were sufficient (or even necessary) to cause a stock price to take off.
Obviously, all of the conditions that make up the ‘CANSLIM’ acronym are desirable things for a corporation — for its management and for its ownership. But that doesn’t mean that the stock in question is about to outperform the market. I’m not a hard-and-fast believer in the semi-strong efficient market hypothesis — I think a few super-stud investors can outperform the market — but for the average investor reading MSN’s Money Insight column, the CANSLIM approach is not going to turn those people into super-stud investors. EMH is still going to apply to those investors; there are just too many other investors who have the same type of information and insights at their fingertips.
In his 1974 commencement address to Cal Tech, the late Richard Feynman described what he called “cargo cult science:”
In the South Seas there is a cargo cult of people. During [World War II] they saw airplanes with lots of good materials, and they want the same thing to happen now. So they’ve arranged to make things like runways, to put fires along the sides of the runways, to make a wooden hut for a man to sit in, with two wooden pieces on his head to headphones and bars of bamboo sticking out like antennas — he’s the controller — and they wait for the airplanes to land.
Feynman (about whom I will have much more to say in an upcoming post) was using the term to deride psychics and ‘paranormal’ advocates like Uri Geller. But the MSN piece is urging investors to do exactly what Feynman describes the naive south island natives as doing: falling hook, line and sinker for a post hoc fallacy.