Hi Guys,
In its May 10, edition, the WSJ honored great stock analysts on an annual basis. The Journal prepared and published an extensive series of articles that featured a listing of the three top master stock pickers in 44 sub-sector equity categories.
These top performers were granted Olympic-like status, similar to the newly minted gold, silver, and bronze metals now awarded by Morningstar in their second ranking formulation. This second Morningstar scoring procedure is purportedly forward looking in character, and supposedly contrasts with its famous “star” system which is fully rear-mirror looking by design.
The WSJ rankings share the same attribute as the Morningstar Star system. The Star formula has revealed its mutual fund selection shortcomings over time. How useful is the WSJ assessments with respect to individual stock picks?
On an individual stock picker basis, the WSJ listings show impressive results for the few category winners. But this is using hindsight bias; the champions for 2011 clearly established their superior records for that calendar year. But could the Journal identify these potential winners before the record was accumulated and evaluated? How persistent is performance over time? An overarching question is how skilful are the stock picker elite as a group? Do they really benefit their clients as a total?
All stock analysts hired by financial firms are smart folks. They have great educations, super support staff, considerable on-the-job experience, and are highly motivated by personal pride, institutional recognition, and financial incentives. If anyone can successfully project future stock price movements, these guys should be the chosen ones.
Intelligence, training and experience do matter. But the impact of these positive factors are muted if the price movements are chaotic by nature because of unknowable exogenous events and by internal complex feedback loops that are not modeled, perhaps not even recognized. The problem is further aggravated by irrational and inconsistent public behavioral responses. Investors reactions change remarkably when confronted with identical decision scenarios. Patterns get distorted over even short timeframes.
Additionally, as Nassim Taleb and Daniel Kahneman observed in their respective “Black Swan” and “Thinking, Fast and Slow” books, luck is a key element in investment outcomes.
Therefore, it is not shocking to discover that, although winners always exist in the stock selection marketplace, that same space also includes a substantial number of losers. The WSJ metal awards do not address the other end of this results spectrum.
But I do. Here’s how.
Besides showing the three superior stock pickers for each of the 44 sub-sector equity categories, the Journal also provides the class median performance for each of these categories. I used that data to complete a simple statistical analysis that yields an overall assessment of the entire host of stock analysts who were included in the contest.
The WSJ scoring system is a little complicated so I have appended a Link to the Journal article that addresses the scoring methodology. It follows immediately:
http://online.wsj.com/article/SB10001424052702303404704577307901542943884.html?mod=WSJ_Investing_MoreHeadlinesIn general, a positive score means that the stock pickers generated a net positive return for investors following their recommendations. Prescient sell signals were also incorporated into the evaluation by reversing the sign on the returns. The higher the net analyst score, the higher the likely client wealth enrichment potential. Note that many individual analyst and category scores were negative for the year, a wealth depleting likelihood.
My simple analysis did not incorporate any weighting factors to adjust for the very disparate expert numbers who populated the various sectors. That refinement would improve the analysis but requires additional work. Given that I’m a bit lazy and out of training after two decades of retirement, I punted on that task. Perhaps a more energetic MFO participant can carry that ball across the goal line.
Unfortunately, you must subscribe to the Journal to gain access to the overarching article titled “What Makes a Great Stock Analyst?” . Sorry about that. Perhaps you can identify an indirect avenue to secure access.
My simple global statistical assessment shows that the analysts as a complete cohort did not add wealth for their clients. All of us have been exposed to similar findings for active mutual fund management. Market experts and pundits promise much, but frequently deliver little.
The mean net return (gains minus losses) for adhering to the analysts’ recommendations was -1.11 units for 2011. Performance variability (standard deviation) was an unattractive 10.31 units. The maximum gain was 16.07, but the maximum underperformance was -23.33. Only 21 out of 44 category groupings (47.7 %) produced positive rewards. These results are disappointing given the talent and resources committed to uncovering attractive stock possibilities. Once again, luck seems to be a dominant factor.
Overall, the WSJ awarded 132 (3 X 44) metals. The awards were scattered among 66 institutional and research firms. Goldman Sacks collected the most metals, 9 out of 63 analysts who qualified from Goldman for the competition. From a research corporate perspective, Morningstar came in third place with 6 metals from a recognized 63 entries.
That concludes a summary of my crude statistical analysis of the WSJ survey. Now some interpretation.
All analysis must be placed in a context framework. How tough was the equity marketplace for the stock picking army? Was there major tailwinds or headwinds? With the benefit of perfect hindsight, it was a mixed bag. In the US, this is appropriately measured by the mixed Index returns for 2011. The S&P 500 returned 2.1 %, the Wilshire 5000 delivered 0.6 % on the positive side of the ledger. The NASD composite absorbed -0.8 % while the Russell 2000 eroded -4.2 % of wealth on the negative side. The recorded returns demonstrated that the marketplace was not easy pickings during the previous year. Perhaps that was anticipated by customers and encouraged them to more fully implement expert advice. Of course, that’s speculative on my part.
However, remember that the WSJ challenge was focused solely on a stock pickers ability to select specific stocks, not overall market behavior. His stock instincts and intuitions were being tested to determine his skill set in that arena alone. He was credited with a positive score both if his buy picks delivered profits and if his sell signals were properly aligned with subsequent performance. The WSJ constructed a fair test to gage stock picking acumen. They formulated a valid scoring method independent of the broad market direction.
Even with my incomplete statistical analysis, we are now in a better position to answer one of the original questions posited earlier: Do stock picking gurus globally reward their clients? My answer is “No”. Some do, but slightly more do not.
This analysis did not consider the costs associated with their task. That cost is a lot of money out of the pockets of the customers and into the deep pockets of the star pickers and especially into the coffers of their resident firms. That’s yet another drag on customers who often underperform annual market returns.
The WSJ’s series honoring star stock pickers is misleading since it highlights the winners but mostly ignores those pickers who subtracted from their client’s wealth. The rating and ranking game is a double-edged sword that demands a broad statistical interpretation that is frequently omitted when promoting an agenda. In his book, Daniel Kahneman described it as WYSIATI (what you see is all there is). The WSJ articles perpetuate this tendency to only deploy the intuitive portion of the brain when making investment decisions while ignoring statistical data that establishes a base rate to make a more informed decision.
So, I am under-whelmed by these findings as presented. Expert knowledge has its limitations, especially in a complex, chaotic environment with few consistent investment rules that survive time, and an unruly, emotional investing public. My analysis morphs the buyer beware bromide into a reader beware context.
What do you think?
Best Regards.
Comments
Luck is an element, but you're in a time frame where size also matters, and the average investor sees their investments tossed around by large hedge funds and/or computer traders.
Personally, I have some broad investments and a number of individual plays around the world that play off of what I believe are longer-term themes (trends that I think play out over a number of years) and alternative investments. Like any other average person, I'm just trying to do what I can. That's all one can really do.
As for analysts, here's a good example: the other day, an analyst with a buy rating on Herbalife (HLF) downgraded the stock because hedge fund manager David Einhorn may confirm he's short it. They liked the stock, but have to downgrade it because what someone else might say.
http://www.zerohedge.com/news/worst-research-piece-ever
That's a good example of the kind of environment this is, where what David Einhorn may say can knock a stock down 20%. No second thought, no reflection of what may be the company's positives. David Einhorn appears on the conference call and everyone falls over each other to get to the exits. Even if it's not David Einhorn, it's some other large name.
I have no idea about Herbalife (Einhorn could certainly be right, as he was in regards to Green Mountain Coffee Roasters), but it's an example of how market forces and the increasingly smaller time horizon result in an example where the thought that he MAY be short leads to people to sell the stock down 20% without a second thought - and the overhang of the possibility of Einhorn being short has sent the stock down even further after the initial 20%.