In the summer of 1976, British wine merchant Steven Spurrier gathered eleven wine experts in the Incontinental Hotel in Paris to conduct a series of wine tastings. The judges were all French, and were all highly qualified and well regarded members of the wine community. As with most wine tasting, this one was done blind. Experts were given a wine with the label unknown to them and asked for their comments. More importantly, they were asked to rate each individual wine out of 20.
Spurrier had put together 10 red wines to be examined. Out of these ten, four were French wines of stellar repute from the French winemaking region of Bordeaux. They included two vintages from the award winning vineyards of Chateau Mouton-Rosthchild and Chateau Haut-Brion. The remaining six red wines were produced across the Atlantic Ocean in Napa Valley, California, an up and coming wine producing region.
The wine list took on a similar fashion for the whites. They comprised of four Burgundies, traditional high quality white wines produced in the region of that same name in France and six Chardonnays from California in the USA.
Old World vs New World.
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At that time, many wine connoisseurs were skeptical of wine being produced in many parts of the world. They believed firmly in the traditional wine producing regions of Europe. They could not see how new upstarts could even possibly challenge the established vineyards who have been in wine craft for hundreds of years.
The session was designed to demonstrate the superiority of French wine over American wines. Spurrier’s business after all, depended on the continued success of the French wine industry. Folklore even has it that while the French wines were carefully selected, the American wines were hastily obtained from American tourists because there was insufficient time to organise their import.
They experts started with the whites. A Californian Chardonnay, the Chateau Montelena took top spot, leaving the very established French Burgundies in its wake. It was a shock for Spurrier.
Nevertheless, all is not lost. Red wines have always been the mightier and more prestigious cousin to whites. Spurrier, with every intention to ensure that the French reds triumphed, informed the judges (somewhat unethically) that an American wine had won the first tasting. The alarmed panel became more cautious and did their best to segregate the French reds from the American.
What happened next took the entire wine world by storm. The Stag’s Leap Wine Cellars 1973, a relatively unknown Californian red wine was given the highest cumulative score by the judges. The illustrious Chateau Mouton-Rosthchild 1970 could only manage second place. Three other Grand-cru Borbeaux, supposedly the best of what French winemakers have to offer, languished mid table.
The Judgement of Paris
Spurrier had set out to prove the superiority of French wines over others. In his mind, and in the minds of the judges, it was never about which wines were better, but rather, by how much were the French better. It was inconceivable that New World wines from the USA, in the glasses and opinion of French wine experts, could beat the very successful French wines. The event was a significant one in wine history, and it became known as the Judgement of Paris.
There were two important implications arising from the Judgement. The first was the emergence of new wine producing regions in the USA, Australia, South America and South Africa. Wines produced in these regions gradually gained acceptance and small credit must be assigned to Spurrier and his panel of experts.
The next implication is this. It showed, in no uncertain terms and for the very first time, just exactly how well wine experts really know their wine. From this incident it seems, not very well at all.
Wine and stocks
The act of drinking wine and investing in stocks have many things in common. Both wine sommeliers and stock analysts are deemed experts in their highly complex field. Qualifications such as the Master of Wine (MW) require at least three years of self study, attending educational seminars submitting essays and tasting notes. The process is challenging and rigorous. Similarly, the Certified Financial Analyst (CFA) programme, almost an unspoken prerequisite for financial analysts, demands very much the same from its Charter Members.
In addition, both are activities commonly engaged by the man in the street. One does not need to be an expert to drink wine; they are available in every restaurant cafe, supermarket and convenience store. One also does not have to be an expert to buy stocks. It is as simple as opening a brokerage account and one has the entire universe of companies is at his disposal. As a result, there is a chasm in the level of knowledge between the noobs and the experts in both wine and stocks.
Because of this difference in the level of knowledge, new wine drinkers and stock investors tend to defer to both sets of experts when in doubt. The question then is – do stock experts perform better than wine experts?
A Random Walk down Wall Street
In 1998 the Wall Street Journal started the classic dartboard challenge. Investment professionals picked their favourite stocks on a monthly basis. The returns of these stocks were pitted against staff members of the WSJ throwing darts at stock names pinned on the wall. This was in response to Princeton Professor Burton Malkiel’s book, A Random Walk Down Wall Street in which he claimed that
…a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts
The contest ran for over a decade before it was retired. Out of the 142 contests, the experts came out slightly ahead with 61% wins. The fact that they lost, four out of ten times, to random picks came out to be a huge embarrassment.
How can Analysts be so wrong?
More recently, nerdwallet ran a study of analysts covering the 30 stocks in the Dow Jones Industrial Average. They obtained analyst recommendations of these stocks before 2012 and over the course of the year, tracked individual stock performances. Only 51% of analysts ratings turned out to be correct. At chance level, an investor would perform just as well by flipping a coin.
In 2002, New York Times financial journalist Gretchen Morgenson won a Pulitzer Prize for her work on a series of articles on the workings of Wall Street. In one if them titled ‘Price Targets are Hazardous to Investors Health‘, she described why it is important for analysts to set outlandish price targets so as to differentiate themselves from the crowd and be noticed.
Professor Laurence Brown of Temple University goes a step further. Not contented with simply studying how terribly wrong the analysts can be, he wanted to find out why they are wrong. He and his team sent out questionnaires to 365 analysts and followed up with interviews. The questionnaire investigated how analysts make decisions, and included questions such as the model they use for their predictions, the amount of direct contact with higher management of the companies they are covering, and other related issues.
One particular question stands out. Brown got the analysts to rank some statements in the order of importance that it will affect his or her compensation. Now in an unbiased world, the more accurate and timely his forecasts are, the better an analyst he is deemed to be and the more compensation the analyst deserves. In the survey, this particular factor actually ranked last. What this implies is that unlike a retail investor, the most successful analyst in the profession does not have to be the one that is right the most often. In fact, being right is hardly a consideration for success. How ironic is that.
Netflix – would you buy or sell?
As a final straw, I took to yahoo finance to examine analyst recommendations of stocks. With analysts being human after all it is reasonable to expect some differences in opinion between individuals. Nevertheless, the following example showed not only ‘differences’, but polarity in opinion on a single stock. Out of 34 analysts covering the stock, 5 said Netflix is a strong buy while 3 houses issued a sell call on the stock. Target price ranged from $215 to $590, a difference of almost 300%. Which analyst would you trust?
The world of wine has many things in common with the world of stocks. We question the experts in both their fields and ask ourselves the same question of them – Do wine experts really enhance our enjoyment of good wine? Can stock analysts really help us become better investors?
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