Copying the stock picks of successful investors to create your own portfolio of stocks? For many people, this is what they actually do when investing in stocks.
And at least to them, this seems to be the easiest and the most efficient way to pick the right stocks that can turn into future multibagger stocks. After all, successful investors would have done their due diligence before investing their own money. Isn't it? So there can’t be much of a risk following such a strategy.
We are talking about Copy Cat Investing, which only sounds good in theory but the reality is very different.
Or what is globally known as ‘Coat-tailing’ successful investors or ‘Side-Car Investing.’
What Exactly Is Copy Cat Investing?
It is fairly simple to understand.
You as a copycat investor have to keep track of what the so-called successful investors/big institutional investors are buying.
And then, just replicate it in your own portfolio!
You may not copy the entire portfolio, but a stock pick from here and a stock pick from there (based on your personal judgement) ends up creating a portfolio of stocks that can be referred to as a copy-cat portfolio.
So How Can You Track These Investors?
There are a number of ways to do it. Some prominent ones are:
- All listed companies need to disclose the names of investors who hold more than 1% of the stake in the company. This can be a source to find which big investor is getting into which company.
- Stock exchanges publish block or bulk details data on a daily basis. This is also a source to find out who is buying what.
- These days, many popular investors take it to social media to share their stock picks. And copy-cat investors end up taking cues from there.
- Another source can be a monthly portfolio disclosure of mutual funds. If a good mutual fund is initiating or building up a position in a stock, the monthly disclosure will tell that very clearly.
In short, there is no lack of information when it comes to finding out which stocks the successful investors are picking up.
No doubt it’s an easy strategy. But the question is whether this strategy really works or not?
At this point, we must remind ourselves that in markets, there are no free lunches. Generating alpha (or outperformance) from stocks requires proper research, skill and adequate allocation. And this has been the secret of successful investing for decades.
So Does It Mean That Copying Successful Investors Don’t Work?
No. It can work at times. But for most people, it would not work consistently. And that is the biggest danger of this strategy.
Common Pitfalls Of Copy Cat Investing
Let us try to understand where this strategy can go wrong and why it would not work for most copycat investors:
- Inability to replicate diversification of successful investors’ portfolio Most big or institutional investors have a large number of stocks in their portfolios. Though the concentration would be higher towards high-conviction bets, they keep adding new stocks to test various investment theses before building on their positions. Unfortunately, most copycat investors do not have the ability or money to replicate such levels of diversification. The result is, that the stocks that they are copying may have a very small position in big investors’ portfolio. But the same will have a big position in the copycat portfolio. Unfortunately, this is where the problem arises. More so, if that particular copied stock idea starts to take a nosedive.
- Inability to replicate investment horizon Most successful investors have a long-term horizon that goes into years. They are ready to wait for years for the long term investment thesis to play out. But copycat investors, they lack patience and end up exiting too early. Result? They are able to copy the stock picks but not the returns delivered by those picks because they exit too early. On the other side of the spectrum is the situation where copy investors end up confusing a trading idea for an equity investment pick. They keep holding it even when the time to exit it has long gone.
- Not enough knowledge / inability to research Most successful investors have enough knowledge (or insider information) about what is going on within the companies. So they are privy to information that in their view, makes it reasonable to remain invested in their stocks even when the stock might be underperforming on an interim basis. Unfortunately, the copycat investor doesn’t have this advantage and hence, ends up taking hasty decisions (generally to exit) if the stock is not performing as well as they want it to perform. To put it very simply, it is difficult for a copycat investor to not panic in times of trouble because he/she doesn’t have the in-depth knowledge of the stock and business behind it.
- Delay in Information This is similar to lack of knowledge. But generally what happens is that the copycat investors source their information from public sources or social media. This obviously is the last source of information dissemination. So by the time, this information is out, it is already a little late. Big investors would have already built up a major part of their positions in the stock via several entities without triggering the disclosure norms. So this delay in information is also a reason why copycat investors are unable to buy in at an investment-worthy price.
- Public disclosure of entry but delayed news of exit This happens a lot. A copycat invest will enter a company as soon as the news of big investor is out in open. But on the other hand, most big investors do not disclose when they are exiting a stock or reducing their stake. By the time this news of exit reaches the common investor, the stock price is already low, and he once again fails to make money.
Here is a pictorial depiction of how a copycat investor generally reacts:
If you observe the above image carefully, you will understand why most copycat investors never make big money. They just react to various news items and never have any idea about the complete picture.
While it does look good on paper or theory to try and mimic the investment picks of successful investors, it is often much harder if not impossible to do so in practice. Coat-tailing or copying stocks of successful investors has its own set of risks that most people don’t understand.
But having said that, it must also be agreed to that tracking the stock picks of big investors can be a useful source of investing ideas. But then, one has to do the necessary homework to understand the reason for the stock pick and not go about copying them blindly.
If you have the skill, time and dedication to conduct a detailed fundamental analysis of the businesses, then you can do it by yourself. Or else, it makes sense to seek help from competent investment advisors who are using smart and well-proven research strategies to find out the growth stocks/multibagger stocks which have the potential to grow manifold and should be a part of the robust long-term portfolio in order to create wealth in the Indian stock market.
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