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Investing Expertise

Can analysts, experts and gurus really give you an investing/trading edge? Should you track the advice of as many as possible? Are there ways to tell good ones from bad ones? Recent research indicates that the average “expert” has little to offer individual investors/traders. Finding exceptional advisers is no easier than identifying outperforming stocks. Indiscriminately seeking the output of as many experts as possible is a waste of time. Learning what makes a good expert accurate is worthwhile.

Regulation FD: Have Some Big Shots Lost Their Privileges?

The Securities and Exchange Commission (SEC) adopted Regulation FD (Fair Disclosure) effective October 2000, seeking to eliminate selective disclosure (for example, to favored securities analysts) by requiring companies to disseminate widely and publicly all material information. In their recent paper entitled “An Examination of the Differential Impact of Regulation FD on Analysts’ Forecast Accuracy”, Scott Findlay and Prem Mathew investigate the effects of Regulation FD on the relative accuracy of earnings forecasts. Have previously privileged analysts lost a private information edge? Using a database covering quarterly and annual earnings forecasts for 3,000 individual analysts, they determine that: Keep Reading

Warren Buffett’s Track Record: Luck or Skill?

In their August 2005 paper entitled “Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway”, Gerald Martin and John Puthenpurackal rigorously examine various possible explanations for Berkshire Hathaway’s superior investment performance. Is it luck? Is it reward-for-risk? Is it outstanding stock-picking skill? Using information on 261 common equity investments from Berkshire Hathaway’s SEC filings and market databases for 1980-2003, they conclude that: Keep Reading

Sophistication + Experience > Behavioral Bias?

In their March 2005 paper entitled “Do Investor Sophistication and Trading Experience Eliminate Behavioral Biases in Financial Markets?”, Lei Feng and Mark Seasholes analyze how sophistication and trading experience of investors affect their disposition behavioral bias (reluctance to realize losses and propensity to realize gains). They define sophistication based on four factors: number of trading rights; initial level of portfolio diversification; age; and, gender. They define trading experience as the number of positions taken since account initiation. Using data from a national brokerage firm in the People’s Republic of China for 1,511 individual accounts initiated on or after 1/1/99 and monitored through 12/31/00, they conclude that: Keep Reading

Brokerage Business Biases Analysts

In the August 2005 draft of their paper entitled “Analyst Conflicts and Research Quality”, Anup Agrawal and Mark Chen examine whether the forecasts quality of stock analysts relates to conflicts of interest from the investment banking and brokerage businesses of their employers. They define forecast quality in terms of: (1) accuracy; (2) bias; (3) frequency of quarterly earnings per share (EPS) forecast revisions; and, (4) relative optimism of long-term earnings growth forecasts. By cross-referencing the forecasts of 3,000 analysts with line-of-business revenue breakdowns for their respective employers (163 different firms) over the period 1994-2003, they find that: Keep Reading

Uncertainty and Analyst Underreaction

In his recent paper entitled “Information Uncertainty and Analyst Forecast Behavior”, Frank Zhang explores the effects of an increase in information uncertainty (from either volatility of underlying fundamentals or poor information) on the behavior of sell-side stock analysts. He hypothesizes that if behavioral biases cause analysts to underreact to new information when revising their forecasts, they underreact even more as information uncertainty increases. Using dispersion in analysts’ earnings forecasts as a proxy for information uncertainty over the period 1983-2001, he determines that: Keep Reading

Regulation FD is Working?

The Securities and Exchange Commission (SEC) adopted Regulation FD (Fair Disclosure) effective October 2000. “The regulation provides that when an issuer, or person acting on its behalf, discloses material nonpublic information to certain enumerated persons (in general, securities market professionals and holders of the issuer’s securities who may well trade on the basis of the information), it must make public disclosure of that information.” In their June 2005 paper entitled “Who is Afraid of Reg FD? The Behavior and Performance of Sell-Side Analysts Following the SEC’s Fair Disclosure Rules”, Anup Agrawal, Sahiba Chadha and Mark Chen assess the impact of Regulation FD on the accuracy and dispersion of sell-side analyst earnings forecasts. By examining earnings forecasts from March 1995 to June 2004, they determine that: Keep Reading

Detecting Wisdom in a Crowded Market

In The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations, James Surowiecki identifies and discusses the three conditions necessary for a crowd to make good group decisions. Applied to the stock market, good decisions means stock prices that reflect the true values of underlying assets. As depicted in the figure below, the three conditions are: Keep Reading

Expert Overconfidence?

In media interviews and in their own columns, expert investors often project high levels of confidence regarding their opinion of market direction and their stock recommendations. Are they overconfident with respect to their private information and/or abilities? In their paper “Overconfidence of Professionals and Lay Men: Individual Differences Within and Between Tasks?”, Markus Glaser, Thomas Langer and Martin Weber analyze whether professional traders and investment bankers are overconfident in their judgments to the same degree as non-professionals. Based on testing of 33 professional traders and 90 investment bankers, and of control groups of advanced students specializing in finance and banking, they conclude that: Keep Reading

The 5-Star Kiss of Death

In his paper “The Kiss Of Death: A 5-Star Morningstar Mutual Fund Rating?”, appearing in the second quarter 2005 issue of the Journal Of Investment Management, Matthew Morey examines the performance of mutual funds immediately after first achieving a Morningstar 5-star rating. Focusing on diversified domestic stock funds from July 1993 to July 2001 (273 funds), he concludes that: Keep Reading

Stock Market Forecasting

If your crystal ball has not been working so well… Keep Reading

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