It's Dumb To Buy 'Smart Money': Wall Street's Rules, Part 5

NEW YORK (TheStreet) -- As in football, the world of business has become a "copy-cat league." Winning formulas are not considered intellectual property.

In other words, where Super Bowl championships were once dominated by the best running teams, it has now shifted to those better at passing the ball. Essentially every team now wants to do what last year's Super Bowl winner did -- which makes sense. There's no point in re-inventing the wheel.

In similar fashion, Wall Street has no shame in mimicking successful formulas -- except in this case it's more than just flattery, it's profitable.

I've never been the type of person who goes out of his way to give anyone more credit than deserved. However, in this case what Wall Street has figured out is that it is smarter than everyone else. But it's not just that: Its brilliance lies more in the fact that it also understands that you believe it.

Allow me to explain.

In the first part of this series, we talked about the importance of making investment decisions more about the bottom line and less about perpetuating the "rules of investing," or the sometimes unspoken myths that qualify your status as an investor but yield little in the way of results.

In the second part, we looked at the myths surrounding portfolio diversification, while the third part as well as the fourth part reminded us, respectively, that it is true there's a sucker born every minute and valuation often means nothing when assessing the investment worthiness of a company.

In this article, we are going to look at the myths associated with the so-called "smart money," a term that I've never liked; nor do I think such a group or entity exists.

It is said that "stupid is as stupid does." If that is true then the word "smart" should also be assessed based on one's results.

With that in mind, I think any investor is as smart as the net effect of his or her portfolio relative to the investment period. So that means the so-called "smart money" should not be based solely on the value of the investment fund or the portfolio but rather on the returns.

This is something that often escapes many investors who seeks to play "Simon says" with their holdings by buying whatever some "smart hedge fund" manager has bought - particularly those investors who are of novice status.

What's more, Wall Street preys on this weakness. Think about it: How else can the value of an investment be immediately raised if not by retail investors buying right after a fund has invested millions? It makes absolutely no sense to me.

Do we really need to know the holdings of "smart money" in order to determine if Apple ( AAPL) is a good investment and why Research in Motion ( RIMM) should be avoided?

After all, wasn't it "smart money" that was so instrumental in Facebook's ( FB) hype-filled IPO? How's that working out? For that matter, Facebook, which continues to battle both fundamental and valuation concerns, represents just how dumb smart money might actually be.

While Facebook is a good concept, its 955 million users just aren't enough to justify its high trading multiple, which remains more expensive than both Apple and  Google ( GOOG).

But if investors believed in their own due diligence and placed less value on those they think are smarter than them, Wall Street would not be the scary place that many perceive it to be. But so it is.

By contrast, these same smart-money bears continue to attack Amazon ( AMZN) suggesting that it is overly expensive. This is insisted upon even as the company continues to prove why valuation does not matter. In terms of reported sales, there aren't many companies of Amazon's size that are producing the level of growth it has demonstrated.

As a result the stock is up 35% year to date and more than 170% in the past three years. "Smart money" has likely missed a considerable amount of these gains.

Clearly, retail investors were the smart ones in this case while "smart money" was left on the sidelines fighting the Amazon story at their own peril.

Bottom Line

I cringe each time I read a headline about some hedge fund manager eyeing a certain stock because I know there are suckers out there who think they should do the same.

However, very rarely do you ever see a headline describing the losses that a "smart money" manager has amassed. Do you suppose that is because those managers are always right?

If it rains, everyone is bullish umbrella companies; in snow storms, the futures of shovels and snowplows tend to soar. Conversely, this has established what I see as the arrival of a wave of "fair-weather" investors.

The only problem is Wall Street is the meteorologist in a place that is considered a casino where it also serves as "the house."

What this means is that in a forward-looking market, in order to win, investors have to be able to spot these trends before they occur, not just place bets on whatever some hedge fund manager has done - by then it's too late to profit.

Investors playing "Simon says" with their portfolios have caused an epidemic of failure, solely by these investors' need to be comfortable.

What's the point of being comfortable? Instead, be smart!

At the time of publication, the author was long AAPL and held no position in any of the other stocks mentioned.

Richard Saintvilus is a private investor with an information technology and engineering background and has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.

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