One of the perennial dilemmas for the DIY investor is how best to deal with the bombardment of buy & sell recommendations from offline and online media. These investment ideas or "tips" may be thrown in for free by newspapers, such as the Telegraph 'Questor' or the Times 'Tempus' columns, or TV broadcasts ranging from Bloomberg to Jim Cramer's "Mad Money". Alternatively, they may be part of a bespoke paid service, in the form of a subscription newletter like those offered by T1ps.com or a dedicated investment publication like the Investors Chronicle. There are even websites like ShareTips365 or Yahoo that aggregate share tips across industry experts, financial publications, brokers and newspaper columns.
As we've discussed elsewhere, it's important to constantly think about and improve your investment idea search strategy in order to maximise the "top of the funnel". So what place should newspaper tips or investment newsletter/tipsheets have in an effective idea origination strategy? Is it worth paying attention to them or, indeed, as some have suggested, should these kinds of tips actually be used in exactly the opposite way as a "Contrarian Indicator" (i.e. is it better to sell when they say buy?).
Essentially, there are two key questions worth considering:
1) Can a fresh newsletter recommendation (or press tip) impact stock prices? (Can tips move the market?)
2) Are you likely to make money by following these recommendation over a reasonable timeframe, after factoring in transaction costs (Do tips beat the market?)
As regular readers will know, we're all about empirical or evidence-based investing at Stockopedia. Reviewing the weight of academic research in this area, generally speaking, the consensus seems to basically a yes to the first question, but a fairly clear no to the second question (although see our caveats in the concluding paragraph).
Can Tips Move the Market?
Some newsletters (or newspaper columns) have very wide readership, potentially reaching hundreds of thousands of retail investors. A new buy or sell recommendation may therefore potentially be a significant market event, especially in the case of a smaller-cap company, leading to both price and volume spikes.
One study in 2001 by Schadler and Eakins studied the performance of stocks selected for Merrill Lynch’s “focus” picks. They found abnormal same-day returns plus abnormal returns in the two days in advance of the announcement. Similarly, Trahan and Bolster (1995) examined 144 buy recommendations made in a variety of columns for Barron’s Magazine. They found significant positive returns on the day of magazine distribution and from day 0 through day 16, and determined that these abnormal returns were more pronounced for smaller firms. However, as we will see, there is very little evidence that this positive effect is sustained, even over the medium term.
A Fleeting Attention Shock....
This temporary price effect - or 'pop' - appears to reflect investor herd behaviour and is consistent with the idea of an "attention shock". When buying a stock, investors are faced with a formidable search problem. There are thousands of stocks from which to choose. Human beings have cognitive—and temporal—limits to how much information we can process. Investor are generally not able to rank hundreds, much less thousands, of alternatives, especially when the alternatives differ on multiple dimensions.
One way to make the search for stocks to purchase more manageable is to limit the choice set - to choose among ten alternatives rather than a hundred. Research by Barber & Odean has shown that many investors manage the problem of choosing among thousands of possible stock purchases by limiting their search to stocks that have recently caught their attention. Investors do not buy all stocks that catch their attention; however, for the most part, they only buy stocks that do.
Overall, it has been shown that individual investors in particular are much more likely to buy "attention grabbing stocks" that have large positive or negative returns, large daily trading volume relative to long-term average trading volume, and/or that are mentioned in the news. In turn, other investors may then pick up the initial signals of positive announcement period return coupled with higher than normal volume and pile in. These reactions seem to cause mispricing, with a price reversal that then follows in the weeks after the announcement date.
Do Tips Beat the Market?
There has been a lot of research into whether it's worth listening to analyst research recommendations - the general conclusion is that the broker recommendation itself is of limited to negligible value, however there is some signal in tracking the change in recommendation or, better yet, the change in earnings estimates. In contrast, there has been less academic research on the value of investment newsletter recommendation or newspaper tips. A key reason for this is that, unlike with analyst recommendations or mutual fund holdings, there is no accepted publicly available source that accurately tracks the long-term performance of newspaper tips, tipsheets or investment newsletter data.
Perhaps the best known source that does exist in the US, at least for newsletters, is Hulbert Financial Digest (HFD), now part of Dow Jones. Mark Hulbert has been writing and publishing HFD for over 30 years, tracking the advice of hundreds of newsletters since 1980 (including Value Line Investment Survey, Dow Theory Letters, Granville Market Letter, and Elliott Wave Theorist). Hulbert tries to be painstakingly accurate, taking such steps as subscribing to each newsletter he tracks under a friend's name -- to ensure that he doesn't receive issues earlier than anyone else. That allows him to establish purchase and sales prices for stocks fairly.
Mining the Hulbert Digest
There have been quite a few academic studies that have analysed the HFD newsletter database (e.g. Graham and Harvey, Metrick, Jaffe and Mahoney, and Kumar and Pons). The common finding is that investment newsletters as a group show no ability to beat an appropriately chosen benchmark via their specific stock picks or via their equity/cash allocation recommendations. For example, using a dataset that covers more than 17 years and 153 different newsletters, Metrick found that:
"Overall, there is no significant evidence of superior stock-picking ability for this sample 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, a strategy of buying past winners does not earn positive abnormal returns.
The Reserve Bank of New York also did a broad-ranging study in 1998 which looked at investment newsletters. This paper analyzes the recommendations of common stocks made in the HFD database from 1980 to 1996. They found that newsletters typically recommend 10-16 stocks. They tend to recommend growth rather than value stocks, smaller than the value-weighted average of market capitalizations. They generally encourage much higher turnover of holdings than found among mutual funds.
In terms of performance, they concluded that:
1) Newsletter recommendations do not on average outperform benchmarks based on market capitalization, book-to-market and stock price. Including trading costs (and newsletter costs), newsletters likely underperform.
2) There is some evidence that the future performance of a newsletter is related to its past performance, when performance is measured by raw returns but this vanishes when performance is measured by benchmarked returns. What persistence exists therefore likely relates to investing style and not stock picking ability.
3) Newsletters do not herd on stock recommendations but tend to recommend securities that have performed well in the recent past (i.e. they generally chase momentum).
4) Newsletters with poor past performance are more likely to go out of business (i.e. there is survivorship bias) .
Chasing Hot Stocks
Another interesting study was done by Borghesi and Pencek in 2011 of 1,572 stock recommendations published over the past 10 years by Kiplinger’s Personal Finance magazine. Kiplinger’s (http://www.kiplinger.com/) is a widely-available US magazine that provides its readers with investment advice. It has a readership of roughly 800,000 per month, targets affluent professionals, and provides its readers with stock picks along with brief explanations.
This study found that Kiplinger’s picks earned a risk-adjusted mean abnormal monthly return of negative 2.58% over the 6-month post-pick period! The pretty lousy post-pick performance could apparently not be attributed to a small subset of stocks or to a particular time frame. Instead, the experts appear to significantly underperform throughout much of the period examined. Furthermore, the analysis found that the recommended firms were larger than average, and that the returns of these stocks generally exceeded market returns before being selected. Their conclusion was that the experts of at least some popular investment magazines bias their analyses in favor of "hot" stocks to appeal to the interests of their more naïve subscribers.
In summary, tips generally appear to offer investors at best average performance (before costs), and usually without the broad diversification benefit of an index fund. Recognising this is not intended to suggest that buying investment publications like the Investors Chronicle or subscribing to a newletter service has no value. This can be an excellent way to keep abreast of market thinking, uncover "scuttlebutt" around specific investment situations, as well as providing a lot of entertainment and a great source of ongoing learning about investing techniques, strategies and tools. And like anything, there are good and bad services. There are certainly some examples of newsletters that have been shown to have persistent outperformance over long timeframes, most notably the ValueLine Investment Survey, and excellent educational newsletters with a real commitment to transparency, like UK Value Investor (Todd Wenning also makes some useful observations about newsletter selection in the comment below).
Instead, the key point is that just looking to tips for generating investment ideas, perhaps in the belief that a given tips writer is "influential", is unlikely to enrich you. The vast amount of choice in the stockmarket makes it challenging for investors to filter for the right ideas. As a result, many investors seek out advice from supposed experts, whether newsletter writers or newspaper pundits, instead of doing their own research. This is an understandable impulse - DIY investing is not for everyone - but, as we have discussed elsewhere, it's worth remembering that faith in experts is often misplaced. In almost every field (politics, economics, finance), they tend to be poor forecasters, being inaccurate, over confident and slow to change their opinion.
Unsurprisingly for a stock screening site, our view is that using an effective investment screening process is usually a better (i.e. more objective and thorough) way to generate ideas than the ad hoc delivery of "tips" via either a newsletter or a newspaper column. Furthermore, should you decide to pursue a tip, it's still important to approach it with the same due diligence rigour as you would any other stock idea, for example by using a systematic checklist like this one by Philip Fisher. Closing your eyes, holding your nose and buying is unlikely to prove rewarding!
- The (Non)Performance of Kiplinger’s Expert Recommendations
- The Performance of Investment Newsletters, Jaffe & Mahoney
- Why even the best newsletters will fail
- The impact of Stock Recommendations on Dutch Television
- The usual suspects: the effects of attention on journalists’ stock recommendations
- Examining An Online Investment Research Service: The Motley Fool
- Internet Investment Advice: Investing with a Rock of Salt