Blog - Investing Notes

March 29, 2006 - The Secret Ingredients of Top Analysts?

What makes a guru, or analyst, good? The research on this question is predominantly "technical" rather than "fundamental," focusing on performance and performance persistence rather than process (hence, the frequent use of the word guru, implying mystical insight). In their preliminary and incomplete paper of November 2004 entitled "Determinants of Superior Stock Picking Ability", Michael Mikhail, Beverly Walther, Xin Wang and Richard Willis seek to identify the determinants of consistent analyst stock picking outperformance. Using a sample encompassing 268,170 recommendations issued by 4,923 analysts for 7,845 firms during 1985–1999 from Zacks Investment Research, they tentatively find that the best analysts tend to:

• Follow fewer industries and firms.
• Have access to better resources (are at larger firms).
• Are more timely, ahead of their peers, in issuing recommendation changes in general and specifically around quarterly earnings announcements.
• Are less likely to skip recommendation levels (for example, "strong buy" to "sell") as their opinions evolve.
• Are better able to predict deterioration in the fundamentals of companies they cover.

Analyst stock picking ability appears not to depend on:

• Experience level (and may even decline with experience, suggesting that effort declines over time).
• The number of companies followed (as opposed to number of industries), suggesting that critical skills acquired apply across an industry.
• Ability to distinguish among firms within an industry, suggesting that understanding industry trends may be more important than understanding individual firm characteristics.

In summary, industry focus (depth) and general diligence (timeliness) produce superior analysis.

Note again that the authors regard this research as preliminary and incomplete.

For related research, see our blog entries of:

3/20/06 on the personality traits of outperforming investors/traders;

3/15/06 determining that the wealthiest investors exhibit studied risk-taking and efficient opportunity research;

12/13/05 for Jason Kelly's market timing thought process;

9/28/05 concluding that experience and expertise can help overcome behavioral biases;

8/10/05 regarding whether individuals are big-picture or little-picture investors/traders;

6/27/05 contrasting optimistic and pessimistic investment styles;

5/4/05 finding that even experts are overconfident of their knowledge and abilities;

4/16/05 examining possible links between psychological factors and trading performance among day-traders; and,

4/12/05 on the characteristics of good hedge fund managers.