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Classic Papers: The Value of Investment Newsletters?

Recent research on the (stock picking and market timing) abilities of experts to generate excess returns has focused mostly on mutual funds and hedge funds. This focus stems from data availability (mutual funds via SEC filings) and headline value (hedge funds). Where is the research on investment newsletters? How do they rate in terms of excess returns? Digging deeper than usual, we find two on-target papers: (1) the February 1995 paper entitled “Market Timing Ability and Volatility Implied in Investment Newsletters’ Asset Allocation Recommendations” by John Graham and Campbell Harvey; and, (2) the November 1997 paper entitled “The Equity Performance of Investment Newsletters” by Andrew Metrick. Both papers draw upon the investment newsletter archive of the Hulbert Financial Digest. Using different aspects of this archive, they determine that: Keep Reading

The Morningstar Mutual Fund Rating System Works?

Can investors count on the widely cited Morningstar mutual fund rating system as an investment screener? In their recent paper “Morningstar Mutual Fund Ratings Redux”, Matthew Morey and Aron Gottesman investigate the relationship between number of Morningstar stars and future performance of mutual funds since June 30, 2002, when Morningstar overhauled their rating system in terms of granularity, risk measurement and treatment of share classes. Focusing on the three-year performance of domestic equity funds that were rated by Morningstar as of 6/30/02 (1,902 funds) and adjusting for fund loads and survivorship bias, they conclude that: Keep Reading

Finding a Use for Analyst Price Targets?

Might the relative sizes of the gaps between analyst target and actual prices indicate degrees of current misvaluation? In other words, is a stock with analyst target price twice its current price a better buy than a stock presently at or near its target price? In their February 2006 paper entitled “Target Prices, Relative Valuations and the Premium for Liquidity Provision”, Zhi Da and Ernst Schaumburg investigate the usefulness of relative gaps between target and actual stock prices as an indicator of misvaluations. Using recently issued target prices for about 1,700 stocks each month over the period 1996-2004, they conclude that: Keep Reading

Got a Winning Personality?

What personality traits, if any, support successful investing practices? In their March 2006 paper entitled “An Intimate Portrait of the Individual Investor”, Robert Durand, Rick Newby and Jay Sanghani investigate the relationships between personality and both investment decisions and portfolio performance. To measure personality, they apply three perspectives: (1) the “Big Five” personality traits (Negative Emotion-Neurotic, Extraversion, Openness to Experience, Agreeableness and Conscientiousness); (2) psychological gender traits (Masculinity and Femininity); and, (3) personality traits of Preference for Innovation and Risk Taking Propensity. Using personality profiles for 21 Australian self-directed investors along with information about their trading and investment performance during July 2004-June 2005, they conclude that: Keep Reading

Two Habits of Highly Effective Investors?

What are the essential habits of highly effective (wealthy) investors? In his March 2006 paper entitled “Why do Wealthy Investors have a Higher Return on their Stocks?”, Yosef Bonaparte analyzes data from the triennial Survey of Consumer Finances to find out why the wealthiest investors achieve superior stock returns. To frame the analysis, he defines two types of investment opportunity search: (1) informal (use of magazines, newspapers, online services and friends or relatives); and, (2) professional (use of experts such as accountants, financial planners and brokers). Using results from recent surveys, he concludes that: Keep Reading

Halloween and January Effects the Same?

The Halloween effect suggests that investors should be in stocks during November through April and in cash during May through October. Is there a connection between the January effect and the Halloween effect, or are they distinct market anomalies? In their March 2006 paper entitled “Halloween or January? Yet Another Puzzle”, Brian Lucey and Shelly Zhao examine seasonal returns to determine whether the Halloween effect is just an imprecise reflection of the January effect. Using monthly return data for U.S. stocks allocated to capitalization-based size deciles over the period 1926-2002, they conclude that: Keep Reading

Reading Between the Numbers

When a company reports earnings or makes presentations to analysts, should investors tune out the verbiage and focus only on the hard financial data? Or, do company executives give soft clues to future firm performance? In their January 2006 working paper entitled “Beyond the Numbers: An Analysis of Optimistic and Pessimistic Language in Earnings Press Releases”, Angela Davis, Jeremy Piger and Lisa Sedor examine the “body language” of the narratives of earnings press releases and test the response of the stock market to this qualitative information. Using textual-analysis software to measure systematically the levels of optimism and pessimism in a sample of 24,000 earnings press releases published on PR Newswire between 1998 and 2003, they find that: Keep Reading

The Entropic Markets Hypothesis

Can the laws of physics and information theory help explain human psychology, specifically as exhibited by investors? In the December 2005 update of his paper entitled “The Physical Foundation of Human Mind and a New Theory of Investment”, Jing Chen: (1) builds upon the similarities between the mathematics of information theory and of physical entropy to explain certain human thinking patterns; and, (2) uses this synthesis to unify understanding of the behavior of financial markets. He posits that human thinking patterns are adaptations evolved (mostly in hunter/gatherer mode) to acquire efficiently the resources needed for survival, as constrained by physical laws. In a mostly theoretical discussion, he offers the following insights: Keep Reading

Aggregate Analyst Sentiment in the Long Run

Does the distribution of analyst buy-hold-sell ratings predict the overall stock market? Is the distribution of ratings for a given firm indicative of the value of those ratings to investors? In the September 2005 version of their paper entitled “Buys, Holds, and Sells: The Distribution of Investment Banks’ Stock Ratings and the Implications for the Profitability of Analysts’ Recommendations”, Brad Barber, Reuven Lehavy, Maureen McNichols and Brett Trueman analyze the distribution of stock ratings at investment banks and brokerage firms and examine whether these distributions can be used to predict the profitability of analysts’ recommendations. Using 438,000 recommendations issued on more than 12,000 firms by 463 investment banks and brokerage firms from January 1996 through June 2003, they conclude that: Keep Reading

The Illusionary Markets Hypothesis?

Can influential traders actively profit from the psychological biases, the not fully rational decisions, of others? In the January 2005 update of their paper entitled “Illusionary Finance and Trading Behavior”, Malika Hamadi, Erick Rengifo and Diego Salzman introduce the concept of illusionary finance, based on the psychology of decision-making under time pressure and ambiguity, and analyze the creation and dissemination of illusions stock markets. They propose that: Keep Reading

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