John Dorfman, investor and Bloomberg columnist, has been following the 4 most popular and hated stocks among Wall Street analysts for the past 11 years.
According to Dorfman’s research:
For 11 of the past 12 years, I have studied the performance of analysts’ four favorite stocks, and the fate of the four they most scorned…Their favorites, on average, were flat during those years while the four stocks they hated most gained about 6 percent annually. The Standard & Poor’s 500 Index had an average gain of about 9 percent.
Wall Street Stinks
Dorfman attributes this bad performance to the fact that analysts are “not all-knowing” and like most human beings, “extrapolate the recent past as a guide to what comes next.” Check out the whole article to see which 4 stocks are currently most highly rated by security analysts and which 4 are currently the pariahs.
Dorfman concludes with a short review of each of the stocks. I’d like to delve just a bit deeper here, though. There is definitely a divergence in Wall Street’s sell side and Stamford’s buy side in the ability to accurately pick stocks.
Buy side vs. sell side: winners vs. losers
Whereas research like Dorfman’s show an inverse relationship of the best ideas in the sell-side community to stock performance, research like Cohen, Polk, and Silli’s “Best Ideas“ and Martin and Puthenpurackal’s “Imitation is the Sincerest Form of Flattery” indicate that investors have a lot to gain by piggybacking the best ideas and cloning guru investor portfolios.
So, why is Wall Street, which is just as smart IQ-wise as the buy-side, so bad at picking stocks? I just don’t think Dorfman’s “they’re just human” critique is sufficient because buy-side guys are human, too. In fact, I’d wager that the majority of good buy-side analysts cut their teeth on the sell-side. Does moving to Connecticut improve stock selection (like to see that research paper)?
Companies like AlphaClone are entirely focused on helping investors exploit the alpha produced by certain professional investors (see my AlphaClone: The cure for investor insanity). Why the divergence?
Rather, there are structural reasons why piggybacking the buy-side works, while aping the sell-side doesn’t. Some possible reasons for this underperformance:
- Wall Street analysts are reactive, not nimble enough with changes in ratings to make investors money on the way up or down
- industry coverage structure requires that each analysts has to have some buys and some sells in an environment that a good portfolio manager may completely avoid such a sector
- unlike popular folk wisdom, good companies don’t make good stocks and vice versa.
- Analysts are trained like MBAs to take a more organic, longer term view on companies while the market continues to focus on shorter milestones
Thoughts? Let me know in the comments below.
[Hat tip: My Investing Notebook]