Stock Picking

This covers the topic of investing in individual stocks and the value, or lack of value, of analysts. The best article on this subject is written is by Jason Unger, shown below. I hope you enjoy reading it.

Here are the points that I would like you to get from this short article:

1) Investment companies hire lots and lots of analysts that get paid lots and lots of money that we pay in fees.
2) Why would these very expensive analysts be hired? To get people to buy and sell stocks, make transactions, with the idea if an expert says that a stock is a good buy that people will buy it and conversely if an expert says sell then people will sell.
3) The article reports on a contest in the 1990's between professional analysts and people throwing darts at the Wall Street Journal hung on a wall. The contest is to see which group could pick stocks that gave the best performance.
4) A theory taught in an investment class is the Efficient Market Hypothesis. This theory says that since everyone is supposed to have the same information and since nobody can predict the future it is more important to select the right category of investment, like stocks or bonds, rather than individual stocks.
5) If you are investing individual stocks what analysts say does matter in the short-term. Analysts can not predict the future and long-term performance.
6) Analysts select stocks that have higher than normal risk to get a higher return which is good when the market is going up and bad when the market is going down.
7) Some manipulation exists when investing in individual stocks which is why my preference is mutual funds.
8) When an investment company tells you about all of their experts the first thing you should think is how much money is this going to cost. The best way to increase your return is to reduce the amount of fees taken from your account.

God Bless,

Larry
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Can Monkeys Pick Stocks Better than Experts?
by Jason Unger on August 17, 2009 ·

The Wall Street Journal's Dartboard Contest
In his popular personal finance book arguing that investors can't consistently beat the market (A Random Walk Down Wall Street), economist Burton Malkiel says that "a blindfolded monkey throwing darts at a newspaper?s financial pages could select a portfolio that would do just as well as one carefully selected by experts."

Sounds like a challenge.

So, in 1988, the Wall Street Journal decided to see if Malkiel's theory would hold up, and created the Dartboard Contest.

How it worked: Wall Street Journal staffers, acting as the monkeys, threw darts at a stock table, while investment experts picked their own stocks. After six months, they compared the results of the two methods. The WSJ even solicited stock picks from some of its readers, and compared them, too.

After 100 contests, the results were in. From Investor Home's great description of the contest:

On October 7, 1998 the Journal presented the results of the 100th dartboard contest. So who won the most contests and by how much? The pros won 61 of the 100 contests versus the darts. Thats better than the 50% that would be expected in an efficient market. On the other hand, the pros losing 39% of the time to a bunch of darts certainly could be viewed as somewhat of an embarrassment for the pros. Additionally, the performance of the pros versus the Dow Jones Industrial Average was less impressive. The pros barely edged the DJIA by a margin of 51 to 49 contests. In other words, simply investing passively in the Dow, an investor would have beaten the picks of the pros in roughly half the contests (that is, without even considering transactions costs or taxes for taxable investors).

The pros picks look more impressive when the actual returns of their stocks are compared with the dartboard and DJIA returns. The pros average gain was 10.8% versus 4.5% for the darts and 6.8% for the DJIA.

So isn't this a victory for professional stock experts? Malkiel says no. He and a number of other commentators point to a number of factors affecting the results, including:

1) The Announcement Effect: by announcing the stocks to the entire audience of the WSJ, it will artificially inflate the returns (in fact, abnormal gains for the first 2 days after publication scaled back between 15 and 25 days later).
2) Pros picked riskier stocks: Case Western Reserve University professor Bing Liang says that, adjusted for risk, the pros' would have lost 3.8% on the market over the six-month period.
3) The Dartboard stocks continued to do well: After the contest ended, the dart stocks continued to perform, while the pros' picks fell from their initial highs after publication.