The Value Of Transparency: Why Methodology Matters

Disagreement makes markets. Every time you buy a stock, someone on the other side has to be selling it. You’re making a bet that the stock is going to outperform in the future; the other person is betting that it will underperform.

This point seems obvious, but it’s one that investors forget time and time again when they try to chase “sure things.” Many ignored this fact when they fell for Bernie Madoff’s Ponzi scheme. They forgot it when they chased highflying stocks like Twitter (TWTR), LinkedIn (LNKD), or Valeant (VRX) (and many others). Any investment that seems too good to be true probably is.

Chuck Jaffe of MoneyLife and MarketWatch.com made an excellent point on this topic in his recent article, “Here’s One Stock Market Tip You Really Want to Follow.”

“On the MoneyLife show, money managers spend the bulk of their time discussing methodology and markets before moving to which stocks pass or fail their personal tests,” Jaffe writes. “In the end, however, what most people remember is the simple buy-sell-hold recommendation.”

That’s a problem, Jaffe argues, because he often gets different money managers taking opposite opinions on the same stock. These are (presumably) sophisticated investors, with similar styles, who have taken a deep look at the same stocks and come to opposite conclusions. For every very smart investor that believes a security is undervalued, there’s usually another smart person with their own reasons to believe that it’s overvalued.

Recently we faced off against another analyst over Valeant Pharmaceuticals. The other analyst put more emphasis on the company’s stated numbers, leading him to call it a good buy. We reiterated our position that VRX has questionable accounting and its business model destroys shareholder value.

Investors couldn’t just look at the headline to make their decision; they had to dig into the logic and methodology of each argument to decide who they thought was right (given VRX’s 50% drop this week, we think that was us).