How to Take Advantage of Irrational Stock Buying

Ask Ralf Scherschmidt if it’s a bad idea to invest right now in European or other foreign companies, and he’ll tell you that most people are seriously underinvested in international small-cap stocks because their emotions are telling them to stay away from the global markets.

The Oberweis International Opportunities Fund (OBIOX) portfolio manager is bullish on Japan, Europe and the U.K. because his stock-picking strategy that uses a combination of behavioral finance and fundamental research has shown him those regions are rife with opportunity.

Scherschmidt’s (left) fund performance year to date totals 17.45% versus recent Lipper Award international small-cap winners Templeton Foreign Smaller Companies Series (FINEX), at 17.06%, and Oppenheimer International Small Company Fund (OSMAX), at 10.66%.

“The fact is that investors can be emotional and they take their money out of the markets at a bad time, which is when the markets are down, but that’s the time to buy,” Scherschmidt said Tuesday during an interview with AdvisorOne in New York.

The German-born Harvard MBA credits his study of behavioral finance, which he says proves that the traditional belief in efficient markets mistakenly presumes that investors act rationally and without emotion.

Post-Earnings Announcement Drift

 “The efficient market hypothesis is wrong, and we take advantage of inefficient stock market anomalies, called post-earnings announcement drift,” Scherschmidt said.

Post-earnings announcement drift, or PEAD, is a phenomenon that caught fire after first being reported in 1968 by University of Chicago accounting researchers Ray Ball and Philip Brown. Published in the Journal of Accounting Research, their findings stated that earnings surprises result in abnormal stock returns that drift in the direction of the surprise for weeks or even months after the earnings announcement.