Friday, June 09, 2006

A Neurologist Called Brain and an Economist Called Metrick

You have probably figured out by now that one of my pet peeves is investing "experts" who seem to know a lot less in reality than they would like you to think. Well, I happen to have run into a serious, if old, academic study on my side. (I know that there are thousands on this subject, but I happen to have run into this one.)

It is well known that investment newsletters are considered to be among the cream of the investing resources. Subscriptions cost from a few hundred to well over a thousand dollars a year. In 1997, a Harvard economist with the incredible name of Metrick* did a study of recommendations given by some of the newsletters in the database of the Hulbert Financial Digest. The sample of was large, and included some of the most respected newsletters. Here is Mr. Metrick's abstract:

This paper analyzes the equity-portfolio recommendations made by investment
newsletters. The dataset spans 16 years, is free of survivorship and back-fill biases, and
includes the recommendations of 145 different newsletters. Overall, there is no
significant evidence of superior stock-picking ability for this universe of newsletters.
Some individual letters do have superior performance records, but this does not occur
more often than would be expected by chance, and these records are never more extreme
than would be expected for the sample size. In addition, while there is some short-term
performance persistence, a strategy of buying past winners does not earn statistically
significant excess returns.

You can find the original paper here.

*Don't be too startled at Mr. Metrick's name. There is a famous neurologist named Brain, and I once heard of a less famous one called Megahed. I also once met a gynecologist called Woomer. These things happen.

Thursday, June 01, 2006

And Yet Another

I must be getting cynical in my old age.

An article dated May 30, 2006, in The Motley Fool says:

Lastly, we had Toro (NYSE: TTC) mow down estimates.... Shareholders have enjoyed a 40% surge in Toro's stock over the past seven months. Maybe that's not as rewarding as a ride on one of the company's grass-chopping machines, but it's one way to keep your greenery in check.

So keep watching the companies that lap expectations. Over time, it can be a rewarding experience for investors -- the kind of surprise that market-watchers relish in the Rule Breakers newsletter service. The average Rule Breaker selection has trounced the S&P 500's market return. Want in? Check out a 30-day trial subscription.

Given the transition from the first paragraph to the second, you might be forgiven for assuming that profits like those which Toro owners gained over the last few months are among the advantages you will get if you buy a paid subscription to The Motley Fool's Rule Breaker Newsletter. Now I don't know what, if anything, that newsletter has said about Toro. I don't have any subscriptions to Motley Fool newsletters. (I once had one which I won as a prize, but I didn't renew it. Among other reasons, their customer service was awful.) However, I do know what they said the last time they mentioned TTC in a free article, on August 23, 2005. The article was very derogatory, and ended up:

As you might imagine, I'm no longer so favorably inclined toward Toro shares. Sales growth is weak (and has been guided lower for the year), debt is on the rise, and here we are talking about "record earnings." I can't deny that Toro has been a great stock over the past five years, but with a transition in management and questionable deployment of capital, I'm no longer so sanguine about the next five years.

It's funny that when the target company does well, The Motley Fool hints that they have been recommending the stock, while actually their published opinion over the roughly the same time period was just the opposite. No, not funny - hysterical.

When I saw that derogatory article last August, I decided to re-research Toro, which I owned, and still do. I couldn't get a clear hold of what to do, so I decided to do nothing, i.e., to hold onto the stock. Of course, I'm happy that that's what I did.

Aside from not trusting paid sources when they report their own past accuracy, that may be the moral of this story: When you don't know what to do, do nothing. At the very least, you'll save transaction costs, which can be meaningful over the long run.

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