Investing Expertise

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

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

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 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

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

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

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

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

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

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