Keynes said investing is like judging a beauty contest, but not your own.
Imagine a contest where you win by picking the faces other people pick. Your own taste stops mattering; you have to guess what everyone else will guess. John Maynard Keynes argued in 1936 that stock markets often work this way, and it helps explain why prices can drift far from any sensible value.
Keynes introduced the image in chapter 12 of The General Theory of Employment, Interest and Money, published in 1936, to explain why share prices swing so much. He described a newspaper competition in which entrants pick the six prettiest faces from a hundred photographs, and the prize goes to those whose choices match the most popular picks.
A naive entrant chooses the faces they personally like best. A shrewder one chooses the faces they think most people will like. Shrewder still, you realise every other entrant is doing the same, so you try to predict what the average person thinks the average opinion will be. Keynes called this the third degree, and wryly suggested some people practise the fourth, fifth and higher degrees.
His point about markets was that investors may price a share not on what they believe the company is really worth, nor even on what others believe it is worth, but on what they expect others to expect. When enough buyers pile in, the price rises regardless of the underlying business, and an early buyer can sell at a profit. Being right about fundamentals matters less, in the short run, than being right about the crowd.
In 2011 the radio programme Planet Money tested the idea with three animal videos. One group of listeners picked the cutest; another picked the one they thought most people would call cutest. Half of the first group chose a particular kitten video, but 76 per cent of the second group did. People could set aside their own taste and predict the crowd, just as Keynes said.
Source: Wikipedia — Keynesian beauty contest · Text summarised from Wikipedia (CC BY-SA 4.0)
