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Who are the best stock pickers?[3 pages, 04/19/00] Introduction | Analysts | Mutual Fund Managers
Magazines/Columnists/Newsletters | Individual Investors
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Magazines/Columnists/Newsletters Current Level of Accountability: Next time you visit your local newsstand, count how many financial magazines DON'T have the cover story "Ten Stocks to Buy Now" (this will be faster than counting how many do). Which magazines are the best at compiling such lists? I don't know, but I wish I did. In the world of magazines and fee-based newsletters, there is currently not much accountability. Readers can record what columnists have said or search a site's archives and see if the columnists were right, but very few people do this because no one has been making it easy to gather the necessary information. Also, during an extended bull market like the one we've been in (at least until a few weeks ago), everyone's picks look good unless you specifically benchmark their performance against a relevant index over the same time period. But as with analysts, even if you look at what they said, columnists' pronouncements are usually so vague that it's tough to demonstrate that they were wrong. They use phrases the way politicians and palm readers do: it sounds like they're saying something, but if you try to pin them down later the statement dissolves in a cloud of ambiguity. Columnists go out on a limb with 'bold' predictions like "If you want to change the risk-reward characteristics of your portfolio next year, small caps may be the ticket." (This is a real example, but I don't want to embarrass the author by citing the source.) Fee-based newsletters have somewhat more accountability than magazine columnists. Specifically, the Hulbert Financial Digest is an offline service providing objective ratings of over 150 newsletters and the 500+ portfolios they recommend. While this is a valuable service, it is fee-based, so most investors don't have easy access to it. Fortunately, Hulbert occasionally publishes some of its rankings in magazines (e.g. http://www.forbes.com/forbes/00/0124/6502156tab2.htm), but not often enough for individual investors to be count on being able to use it consistently. Performance: Shouldn't the celebrity stock analysts who appear daily on CNBC and CNNfn have been able to warn us about the recent 25% drop in the Nasdaq before it happened, rather than telling us now how we should have seen it coming? Last week I happened to catch a few minutes of Stockpicking Friday (yes, CNBC devotes one day a week to the activity). A caller asked the guest which direction a particular stock was going to go next, and the CNBC commentator said "If we knew that, we'd be on a beach in Tahiti instead of sitting in this studio" or something to that effect. The guest was not amused, but the commentator was right on the money. According to Hulbert Financial Digest and other sources, newsletters as a group consistently lag the indices, and that's before factoring in the subscription costs they charge. Similarly, investing magazines as a group do not provide great stock picks. While there is no aggregate data I can cite, I did gather recommendations from several leading magazines and checked the performance of those picks. Some outperformed the S&P 500, some didn't, but on average they appeared to do about as well as a dart thrower. Some magazines made it easy for me to collect this information (e.g. http://www.kiplinger.com/magazine/archives/1999/portfolios.htm), and they do deserve credit for imposing some accountability on themselves and the pros they get the picks from. Other magazines made it more difficult to gather the performance data, and perhaps not coincidentally those tended to be the ones with the worst records. Explanation for Performance: Why isn't the performance of magazine columnists better than it is? The main reason is that magazines must emphasize quantity even if it means sacrificing quality. Back in late 1996 and early 1997, shortly after I launched InvestorGuide.com, my plan was to pick stocks and write up my research on them. I started choosing stocks I believed in but found that I had to research ten or more stocks before finding one worth recommending - meaning I would have time for little else. I picked a grand total of five stocks over a nine-month period (Cisco, Microsoft, U.S. Robotics (later acquired by 3Com), Amazon, and Charles Schwab) - in the spirit of accountability, I would like to publish their performance thus far but humility prevents me (if you're curious, email me and I'll send you the numbers, or you can use InvestorGuide's research tool to check for yourself). In nine months, I wasn't able to find as many great stocks to recommend as most columnists can find for a single article. Since individual investors don't have the tools they would need to differentiate between good and bad, they become drawn to quantity rather than quality. A similar problem exists in the fee-based newsletter world, with the additional problem that the barriers to entry are low and so it doesn't take much to start publishing a newsletter. While some undoubtedly have investing ideas that are worth more than their subscriptions cost, many do not, and there's no free, easy way for investors to tell the two groups apart. Sites Working to Improve Things: A few magazines, newsletters and web sites publish their portfolios and track them so you can see how they're doing, but you have to trust them; there's no third party auditing the numbers. The Motley Fool pioneered the idea of stock picking accountability, by using real-money portfolios and announcing buys and sells before they happen, along with detailed explanations for those trades. (Unfortunately the jury's still out on whether it deserves commendation for its portfolio policies... http://www.forbes.com/forbes/98/0223/6104146a.htm seems to conclude that the Motley Fool's picks aren't nearly as good as they appear to be, as they have apparently simply stopped tracking some of their underperforming portfolios, including one that reportedly lost 50% in less than a year.) An even more notorious example of inadequate accountability was the Beardstown Ladies. Remember them? Their claims that they had been racking up Buffett-sized returns of 23.4% a year, a feat they said any investor could copy, put their books on the bestseller list... until someone took a look at their records and discovered that they had in fact been underperforming the S&P 500. Fortunately, they fell into obscurity after this discovery. (for a full account, check out http://www.time.com/time/magazine/1998/dom/980330/business.jail_the_beards12.html). The fact that they fell off the bestseller list as soon as they were exposed implies that there is at least some accountability here; the fact that they were on the bestseller list at all means there isn't enough. One web site working to increase stock picking accountability among columnists is the Reese Group, at reesegroup.com. The Reese Group reads all the leading magazines and newspapers and records what columnists say about specific stocks, so you can later check the performance to see which ones are best at stock picking. Unfortunately this is as much art as science, as some columnists are vague about their picks and pans, probably in order to fight such accountability. In those instances the Reese Group makes a judgment call in interpreting what the columnist was really saying. (If columnists don't want to run the risk that the Reese Group will misinterpret a pick for a pan or vice versa, perhaps they will feel sufficiently compelled to make their picks and pans explicit.) The Reese Group tracks whether you could have done better than investing in an index by listening to a particular magazine, column, author or analyst by acting on his/her advice at the close of the next business day after receiving the information. When I visited the Reese Group site, it appeared that some of the data had not been updated in quite awhile, but if the site becomes more popular I expect they'll be able to more actively maintain it. Another site working to increase columnist accountability is BigTipper.com, which I also mentioned in last week's discussion of analysts. BigTipper.com provides a database of columnist picks and the returns on those stocks as well as an average return for each columnist. Unfortunately the site does not yet provide comparisons to benchmark indices, so almost everyone looks pretty good in a bull market and bad in a bear market. Hopefully sites like the Reese Group and BigTipper.com will give magazines and columnists an incentive to emphasize quality over quantity when making stock recommendations. The effect will probably be more pronounced for specific columnists than for magazines, since magazines do a lot more than just pick stocks and since it's unlikely that any magazine will be consistently better than any other magazine at stock picking. Those few columnists who do show themselves to be superior stock pickers will be able to use the internet to develop a huge readership. Also, some magazines are helping to increase accountability, by indicating whether the columnist has an affiliation with any of the companies mentioned which might bias what he/she has written. Some articles just say "The author may hold a long or short position in some of the companies mentioned", which isn't as helpful as a specific list, but it's a start. The practice isn't as common as it should be, but hopefully it will continue to become more prevalent. In the area of fee-based newsletters, the Hulbert Financial Digest is already working on the accountability issue, but as I mentioned it's fee-based. I'd like to see Hulbert offer the service for free online, supported by advertising, but I don't expect it to happen. Perhaps a startup will do it instead. Individual Investors In the two previous parts of this essay, I investigated the various types of stockpicking 'pros' and found that for a variety of reasons their performance left a lot to be desired. Does that mean that there's no place for an individual investor to turn to get stock recommendations that are worth listening to? Actually, there's a new breed of sites that believe that there IS a place individual investors can turn... other individual investors! Could individual investors possibly be better than the so-called experts? While the idea has met with a lot of skepticism by the powers that be, it might not be so outlandish. Consider the evidence...
Obviously, not all individual investors will be good stock pickers, and in all likelihood they will, on average, do about as well as the overall market. But even if individual investors as a category are poor stock pickers, as long as there is even a small percentage who are consistently good, the population of individual investors is so huge that there will be hundreds or thousands worth listening to. Of course, the key is being able to identify the consistent outperformers, so we can separate the contenders from the pretenders, which leads us back to accountability. Accountability is just as important for individual stock pickers as it is for analysts, mutual fund managers, columnists and newsletter publishers. In fact, it's probably more important, because individual stock pickers don't have reputations to protect (at least not yet). I would like to cite evidence to support the claim that many individual investors are good stock pickers, rather than resorting to speculation, but I wasn't able to dig up the relevant statistics. This is probably because, until very recently, the prevailing wisdom was that individual investors had nothing important to say, and so it would be a waste of time to track their performance. But things are rapidly changing. Several sites do accept the premise that at least some individual investors are able to outperform the market and the professionals, and they're going to try to prove it. iExchange is probably the fastest-growing site for stock recommendations from individual investors. Backed by internet incubator idealab, iExchange invites individuals to contribute research reports on stocks, along with target prices and dates. iExchange tracks the performance of each stock picker and ranks them based on average rate of return, directional accuracy, and predictive accuracy. What's in it for the individuals? While most of the research reports are free, individuals are able to charge for their reports if they choose to. Presumably, once a few investors have a track record of consistently good picks, other investors will be willing to pay something for research from these stock picking stars. Validea from the Reese Group is a similar site. They also track the performance of individual investors, and they even compare individual investors to columnists and periodicals. Also, according to co-founder Keith Ferry, Validea will shortly begin tracking online computer models the same way it rates human stock pickers, so even if you're not a good stock picker, maybe the software you write will be. The site's look and feel is very professional, but the data is pretty sparse: as of this writing, only ten individuals have made 10 or more recommendations. There are several other sites taking baby steps toward bringing accountability to individual investors. StockJungle tracks investors' picks, lets other investors rate and comment on them, and provides cash prizes for the best stock pickers. Predict-It lets individuals predict stock prices as well as sports events, political elections and entertainment happenings, and also pays cash prizes for top performers. ClearStation, which was acquired by E*Trade in March 1999, is a variation on traditional stock message boards. It tracks and displays the entire portfolio and performance for each member, so you can see who's worth listening to. The idea of individual investor stock recommendations is certainly not a slam dunk. One major issue is whether the data these sites collect will be sufficient to demonstrate that certain individuals are consistently good at predicting price movements in the stocks they follow. As these sites grow in popularity, Statistics 101 tells us that there are going to be some strong performances even if there are no strong performers. If you fill a stadium with coin flippers, the odds are that a couple dozen will flip heads ten times in a row. If there turn out to be slightly more outperforming stockpickers than the laws of probability would predict, users will still be stuck with the problem of differentiating between the genuinely good pickers and those who got lucky. There's an additional problem. In the mutual fund industry, investors are often encouraged not to chase last month's hot fund, because the correlation between last month's performance and next month's performance is low (or possibly negative). Mutual fund rating services recommend that investors look at a fund's long-term performance (e.g. five years), to better judge whether the fund is a consistent winner. Since these individual investor rating sites are new, it's going to take a long time before their users are able to differentiate between consistent winners and lucky guessers. Furthermore, there's the issue of identity. These individuals don't have reputations to protect, and actually have a relatively high degree of anonymity on these sites. Are there sufficient mechanisms in place to prevent someone with a bad record from just signing up again to get a clean slate? There don't appear to be yet, and it's an issue that these sites will need to resolve if the performance data they track is to be of any value. Additionally, some of the stock recommendations will be made by people with a vested interest, either fairly innocuous (e.g. those with a long or short position) or more insidious (e.g. people being paid to tout a stock). However, the latter can largely be avoided by focusing on stocks traded on NYSE, AMEX and NASDAQ NM. Also, such conflicts of interest are already an issue for any type of recommendation, and should be less so given the high level of accountability... it will be very easy to check a given investor's recommendations, and those that give in to such conflicts of interest will in the long run find their performance suffer and their ability to attract an audience dwindle. There is one final issue: the government. The Securities and Exchange Commission believes (probably justifiably) in fairly tight regulation of investment advice, and may not like the idea of individuals telling other individuals how to invest. Most of these sites include disclaimers like "None of the information presented should be construed as investment advice. You are advised to consult a professional financial advisor before executing a security trade based on information obtained from this site." They do this to avoid lawsuits, but I suspect that most users ignore the warning and use the information they find as investment advice. Depending on how things play out, the SEC may decide to clamp down on individual investor recommendation sites. Despite these obstacles, I am optimistic about the future of these sites, and I'm confident that the major issues will be resolved and that they'll become an increasingly popular way for investors to get stock research and ideas from each other. I'd like to see some of the popular analysts, columnists and other pros become members of iExchange and similar sites so they can show just how good they are. I suspect that they would be, on average, no better than individual stock pickers; and I suspect they know this, which is why they probably won't do it. But it would be nice. Final Thoughts In this three-part essay, I've discussed the likelihood that stock picking accountability will increase in several different categories: analysts, mutual fund managers, magazine columnists, newsletter publishers, and individual investors. Signs point to 'yes' for several of them, but not all. Would that be just a partial success? No. Those areas in which accountability increases will become more popular, to the detriment of the other areas. What about all the conflicts of interest I discussed? They aren't going to magically go away. But they don't have to. The conflicts of interest will remain, but those stock pickers who cave in to conflicts of interest will be suboptimal pickers and their trackable results will reflect it. There's no need to address whether these conflicts of interest will be resolved on a case-by-case basis, because the resolution will be the same for all of them. The sites I featured are taking baby steps toward accountability. I pointed out shortcomings in their strategies not to argue that their efforts won't work, but to encourage them to make improvements, and to encourage others to follow their lead, because I am confident that before too long it will work. Hopefully this essay will inspire a few more startups to take up the cause and increase the level of stock picking accountability. We plan to watch their progress, and if we find that the progress is slower than it should be, we at InvestorGuide.com will join in, because, quite simply, it makes sense. Update 7/23/01: There has been a definite improvement in the situation since I wrote this Tomments, although not quite as much as I had hoped for. Thanks to the free flow of information online, more investors are becoming aware of the conflicts of interest and poor performance of the various stock picking 'gurus'. In fact, as described in Tomments 9, the SEC is finally dealing with conflicts of interest in the analyst recommendation game. But the sea change I was hoping the internet would enable hasn't happened yet; although there are a slowly increasing number of sites ranking stock recommendations, they are not yet sufficiently popular to have a meaningful impact. But as with many internet-related trends, it's a question of when rather than if. I continue to believe that the internet will give rise to a higher level of accountability for all stock pickers. back to top previous | page 3 of 3 Send feedback |
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