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Last week, I met a good friend of mine who always believes in quality and brand in everything. He was discussing about his investment portfolio,he made recently which includes the stocks that are highly priced fancy stocks which are trading far above their intrinsic value. Listening to his portfolio might awestruck anyone but given his 8-10 year view, is it really a good idea to hold such highly overvalued stocks in your portfolio and that too at such higher levels? Those stocks have already discounted its greatness going forward. In my view the companies which belongs to the sectors like metals, realty,etc which are highly undervalued and people are ignoring them at this moment, has more potential in terms of delivering better returns in long term.There are some companies in these sectors having zero debt, very high cash reserves, huge assets etc but is presently trading at cheaper value because of the downturn in their business cycle or the sector has just started reviving but it has a great potential in terms of its business once the sector revives. Nassim Nicholas Taleb says, “ What fools call wasting time is most often the best investment”. These may look like a penny stock but it may not be a penny business. Investing in such undervalued stocks may fetch us far better returns over a longer term time frame rather than in overly priced stocks which are in limelight and has already discounted its richness.

I would like to elaborate this with an example. Have you ever noticed Mark Zuckerberg and Steve Jobs in public appearances. Yes! but have you noticed that Mark Zuckerberg always wears the same grey t-shirt while Steve Jobs always used to wear the same turtle neck t-shirt for all its public stage performances. These billionaires could buy anything on this planet but however they still wear the same dress all the time. So if we look into their content, then nothing can match them in their capabilities but in terms of their appearance, they are very simple because they don’t feel like wasting their time and energy on unimportant work rather focus entirely on the important aspects. The point of discussing it is that are you among one of them who would love to have good looking stocks in their portfolio or the ones which may not appear good on their face but are actually not bad and may fetch better returns in future. This situation reminds me of William Shakespeare who says, “What’s in a name?”.

Lets come back to our topic. So instead of looking for a stock which has already become multibagger, lets search for stocks which may become the next multibagger. In case of overly priced stocks, the price which we are paying is more than its value which seems a bad idea in terms of returns it may generate over the years to come. Rather we should look for those stocks which are not in limelight and is highly beaten down but there is a good margin of safety in those stocks. Warren Buffett says, “Price is what you pay, value is what is what you get”. The reason why people go for this overly priced stock is that now every tom, dick and harry talks about its greatness and is in full limelight. Here comes the bias of social proof also known as herding mentality. In short, monkey see, monkey do. As per Wikipedia, social proof is – a psychological phenomenon where people assume the action of others in an attempt to reflect correct behaviour for a given situation. This effect is prominent in ambiguous social situations where people are unable to determine the appropriate mode of behaviour and is driven by the assumption that surrounding people possess more knowledge about the situation. As far as human behaviour is concerned, German Swiss philosopher Friedrich Nietzsche was accurate in his observation when he said, ”Madness is rare thing in individuals but in groups, parties, peoples and ages; it is the rule”. It is not only the common people but also the highly qualified portfolio managers are not untouched of this social proof bias. If we analyse the portfolios of majority of mutual fund managers, you will discover that they’re more or less similar and we hardly find any manager taking a big and against the consensus call. Moreover their returns also do not differ much. Warren Buffett says, “Most managers have very little incentive to make the intelligent but with some chance of looking like an idiot decision. Their personal gain or loss ratio is too obvious; if an unconventional decision works out well, they get a pat on their back and if it works out poorly, they get a pink slip (failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemming has ever received bad press”. A lot of retail investors exhibits social proof tendency in their investment decision. They hold a particular stock because most of the people in their investment group are positive on that stock. John Maynard, one one of the most influential economist in the 20th century says, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally”

Read: Portfolio diversification simplified

It is a more better idea if instead of going with the herd behavior, you should carry out your own independent research because in case of heavy selling, you are not among one of them selling their portfolio in panic but the one, adding onto the portfolio if opportunities come. Benjamin Graham, the highest authority on security analysis reminds us, “You’re neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right”. It may happen that 50-60% of the stocks in the portfolio might under-perform or not perform at all but the ones which work in your favor might give you good returns over the long term. George Soros says,”Its not whether you are right or wrong thats important, but how much you make when you are right and how much you loose when you are wrong”.