Investing Expertise

Does a natural selection metaphor apply to stock picking models? In other words, can competition among a large set of dynamic models to mimic historical stock performance data evolve the most fit models? In their May 2006 paper entitled “Stock Selection – An Innovative Application of Genetic Programming Methodology”, Ying Becker, Peng Fei and Anna Lester address these questions by applying genetic programming to stock picking. Genetic programming enables the testing of a wide range of stock performance indicators in linear, non-linear and non-obvious combinations. The authors choose the S&P 500, excluding financials and utilities, as their universe of stocks and define two distinct types of stock-picking model fitness: (1) risk-adjusted outperformance compared to a traditional stock-picking model; and, (2) highest possible return independent of risk. They construct for comparison a traditional stock return forecasting model based on a linear combination of four composite factors: valuation, quality, analyst expectations and price. They use monthly data (65 variables for each of about 350 stocks) over the period January 1990 through December 2005 to create environments for model development and out-of-sample testing. They show that: Keep Reading

In his article entitled “The Seer-Sucker Theory: The Value of Experts in Forecasting” from the June/July 1980 issue of Technology Review, Scott Armstrong investigates the general supply of and demand for expertise across several disciplines. Based upon his survey of decades of research in multiple fields (including financial markets, psychology, health care, politics, sports), he concludes that: Keep Reading

In his 2005 book Expert Political Judgment: How Good is It? How Can We Know?, Philip Tetlock describes the results of his long-term systematic measurement of the forecasting abilities of political experts. These results include insights into the critical success factors of forecasting. Making the very small leap that these insights apply also to experts in economics and financial markets, we offer here a chapter-by-chapter review of the insights in this book: Keep Reading

We get a varying flow of traffic from Yahoo! message boards, usually from boards of “Cramerized” stocks to either our review of Jim Cramer’s market timing record or our evaluation of his stock picking ability. Who reads these stock boards? Using a sample of 212 unique Internet Protocol (IP) addresses for readers recently visiting from five different Yahoo! message boards, we find that: Keep Reading

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: Keep Reading

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

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