Larry Putnam

Magical Run or a Bunch of Hype?

Business Week is a respected bastion of the financial media. Like much of the mainstream media, the magazine has a penchant for publicizing trading successes. In its July 24th issue, BW printed a 4-page analysis of "Inside Wall Street" columnist Gene Marcial's stock picks for 1999. The article concluded that columnist Marcial had a "very good '99" and called his stock-picking results "impressive" and "sensational" for last year.

The article presented several pages of numbers supposedly showing Marcial's weekly 1999 stock tips "trouncing" several indexes - the Dow Jones Industrial Average (DJIA), Standard and Poors 500 Index (S&P 500) - and slightly trailing the Nasdaq Composite Index (Nasdaq). Business Week measured the price performance of each stock recommended in Marcial's column during 1999 and compared price performance against the S&P 500, DJIA, Russell 2000 and Nasdaq benchmarks. Price performance was measured against these indexes one day after the column was printed as well as 1 month, 3 months and 6 months after publication of the stock tips.

Business Week eagerly reported that Marcial's picks were up an average 8.8% the day after they appeared in print in 1999. This compared to an average daily increase of only .5% in the S&P 500 index in 1999. Of course Marcial's picks jumped the day after publication! Day traders hoping to make a quick buck bought his popular picks and gave his recommendations a quick boost the day after they were released to the public. Whenever a brokerage firm releases a buy recommendation on a stock or Joe Kernan broadcasts positive comments about a stock on CNBC, hype-reactions happen. The short-term momentum traders react and "pump" the recommended stock's price higher. Later (a few minutes, a few hours, a few days), the day-traders "dump" the stock and long-term investors or inexperienced day-traders who get sucked into this game lose money - sometimes lots of money.

It's very interesting that this comment appears at the end of each Marcial column: "Watch for Gene Marcial's 'Inside Wall Street' column every Tuesday afternoon at www.businessweek.com/today.htm". This is a clear signal and open invitation to day traders to pump up his stock picks.

Let's take a closer look at Business Week's claim that stock-picker Marcial "trounced" most indexes and slightly trailed the Nasdaq index in 1999.

When comparing the price performance of a group of stocks to a benchmark index, it's important to compare apples to apples and oranges to oranges. In other words, when you take a look at the 155 stocks that Gene Marcial recommended in 1999, it's important to figure out the major types of stocks within the group of 155 and to select a benchmark index that makes sense in measuring price performance.

For example, 85 (or 55%) of Marcial's 155 picks for 1999 trade on the Nasdaq and American stock exchanges and are predominantly small-cap tech stocks. The other 70 picks (45%) trade on the New York Stock Exchange. Calculating an expected rate of return for the Marcial picks for 1999 using the Nasdaq and the New York Stock Exchange Composite Indexes (weighted 55% Nasdaq and 45% NYSE Composite), these 155 stocks should have increased in price an average of 51%.

However, Business Week reports an increase of only 26% for Marcial's 1999 stock selections, a significant underperformance compared to the 51% expected rate of return if the correct benchmark indexes are taken into account.

Suddenly, Marcial's 1999 stock tips don't look so hot.

Something else to think about: nearly half these 1999 picks were priced under $15 per share; 33% (one-third) were priced below $10 per share. Low-priced stocks (especially shares priced under $10) are often considered "penny stocks" and carry heavy risk and are volatile (they move up and down in price a lot, creating churning stomachs for long-term investors). "Beta" (a measure of volatility for a stock's price, anything above the number 1.50 is considered super-volatile) was examined for Marcial's picks showing 18% with Beta measurements above 1.50. Another 12% of his picks have "N/A" listed in the Beta column, which often means the Beta number is so astronomically high (it approaches infinity), it isn't listed. In down-to-earth practical terms, this means an investor can wake up thinking he owns a stock worth $15 and after just one day of wild trading, the stock can shoot up (or down) huge percentages of 50% or more, settling at $29 (or $1).

In rethinking the Business Week article, why would an investor buy Marcial's stock tips? Hot stock tips usually burn the investor over the long haul. Consider buying an index fund based on the underlying benchmark index (such as the Nasdaq or NYSE composite indexes) for good, long-term price performance without the heavy burden of risk from over-hyped stock tips.