Friday, May 18, 2007

No Secrets to Conceal

This article, used with permission, is from Jim Parker, Regional Director, DFA Australia Limited:

May 2007
Jim Parker

The cover of one recently published investment magazine promised readers an insight into "secret stock plays"—the hot stocks that fund managers favour but don't want the general public to know about.1

One would have to assume that those "undiscovered" cover story stocks are a little less of a secret now that the magazine has appeared on the racks of tens of thousands of news agencies around the country.

This is the irony of media stories that proclaim to provide inside knowledge on what the "experts" are investing in. The information quickly loses whatever value it was purported to contain once it is no longer exclusive.

Indeed, there is old adage that once newspapers and magazines start spruiking companies in cover stories, it is time to sell. Likewise, when they write companies or asset classes off, it is said to be a time to buy.

On that last point, some might be old enough to remember a famous cover on US Business Week in 1979 which proclaimed "The Death of Equities", an edition which was published just prior to the start of one of the greatest bull markets in history.

Now, some flesh has been given to the folklore with a new scientific study looking at whether cover stories are indeed contrarian indicators.

The study2, written by three professors from the University of Virginia and published in the Financial Analysts Journal, collected headlines from Business Week, Fortune and Forbes magazines over a 20-year period.

The aim was to determine whether positive news stories were associated with superior future performance and negative stories were associated with inferior future performance for the featured company.

"Superior" or "inferior" were determined in comparison with an index or another company in the same industry and of the same size. The time period for the study was 500 business days on either side of the publication.

The authors found that the appearance of a company on the covers of one of those investment magazines tended to signal the end of its extreme performance—whether negative or positive.

"Statistical testing implied that positive stories generally indicate the end of superior performance and negative news generally indicates the end of poor performance," the study concluded.

So does this mean you can profit by short selling those companies getting favourable magazine coverage and aggressively buying those who are getting dumped on? The study authors found it isn't that simple.

Indeed, they conclude that while the stocks featured in positive cover stories don't out-perform the market on average after the story appears, they don't under-perform it either.

Equally, negative cover headlines don't provide a good signal for momentum or contrarian strategies when performance is measured against an index or measured on a size/industry-adjusted basis.

To anyone who believes the market does a decent job overall in assessing the prospects of individual stocks, this is good news.

In other words, while magazines claim they are uncovering great investment "secrets", it is highly likely that whatever information is included in a cover story will already be priced into the stock.

What's more, there is little evidence that you can do better than the market by using media coverage as a contrarian indicator.

This is not really surprising given the easy availability of real-time business and financial news these days and the difficulty of monthly or fortnightly magazines revealing anything new about a company.

That's not to say these stories don't make for an entertaining read. But if you really want to know how a company's prospects are rated, the market is a pretty good place to start.

So rather than trading off magazine covers, the prudential investor will concentrate on capturing the returns that the market offers, diversifying to wash away volatility and keeping a focus on the long term.

1"Secret Stock Plays", Financial Review Smart Investor, May 2007

2Arnold, Tom; Earl, John H. and North, David S., "Are Cover Stories Effective Contrarian Indicators?", Financial Analysts Journal 63 (2007); 70-73

Monday, May 07, 2007

A New Model For Advice

This presentation, from Dimensional and targeted more to Advisors, provides further insight into my business model and the value provided to clients by this model.

This material is provided for information only. No account has been taken of the objectives, financial situation, or needs of any particular person. Accordingly, to the extent this material constitutes general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, have regard to the investor's objectives, financial situation, and needs. This is not an offer or recommendation to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.