Follow Stock Analysts So You Can Ignore All Their Advice

A fun, strange fact: There's a lot of money in the stock market. Multiple industries, sky-high careers, and scads of expert opinions all stake their existence on investing. It's worth listening to their thoughts on the market, because new research suggests that ignoring them will make you a lot more money.

Economist Nicola Gennaioli of Milan's Università Bocconi has just released a paper showing a profound difference in the rate of returns on stocks favored by analysts versus those they're pessimistic about. Surprisingly, the top 10 percent of stocks recommended by U.S. analysts yielded about 3 percent each year; stocks from analysts' bottom 10 percent yielded an annual average of 15 percent instead. (Keep in mind that whether 3 percent of one stock out-earns 15 percent of another is another story.)

It all comes down to a principle called representativeness. As Gennaioli puts it in a video, "Beliefs exaggerate true patterns in the world." We believe everyone from Ireland is a redhead because of a stereotype, but even though redheads are rare in the rest of the world, only about 1 in 10 Irish people are redheaded. We look at stocks we think are representative of successful stocks and are inevitably disappointed when it doesn't turn into Google. Of course, even though stocks like Google are more common among well-performing stocks, we forget that they are rare in absolute terms.

In short, look for the dark horse stocks — not demonstrably poor performers, but the ones analysts actively underestimate. The expectations for success are much lower, and you may get in early on a good deal because of it.