Stock-Picking Contests Are No Way to Pick Stocks

(Bloomberg Opinion) -- Let’s give Barron’s credit: of all the various stock-pick-a-thons I see each year, theirs is the most honest. The publication reviews its own performance, doesn’t crow too loudly when winners emerge and admits when they stink it up. “Last year was a tough one for equities, and our picks had it slightly rougher,” the editors wrote last week. This is as much transparency as one could hope for, setting the standard for those who publicly select or write about stocks for public consumption. Other outlets should follow the practice of acknowledging their track record as well as Barron’s does.

But the problem with these contests isn't transparency or lack thereof, but rather that the entire exercise is futile because the outcomes are entirely random.

This isn't an argument that selecting stocks is either irrelevant or futile. Identifying equities worth buying is still a substantial and important aspect of investing. If that surprises you to hear from an indexing advocate, well, it is simply a fact. The vast majority of investments are NOT held in low-cost passive index funds. Yes, passive has become a large force, but it still accounts for a relatively small portion of assets invested globally. Vanguard Group founder Jack Bogle noted late last year that U.S. index mutual funds have grown from 4.5 percent of total U.S. stock-market value in 2002 to about 17 percent in 2018. Indexing accounts for an even smaller percentage worldwide.

We have to ask whether any useful purpose is served by holding runoffs. Let's try to address this in two ways by pointing to the two inherent defects of the entire process.

The first is the one-size-fits-all approach. A retiree looking for income, a patient 20-something with a 50-year time horizon, and a high-earning middle-age professional saving for retirement all have very different investing needs. The typical stock-picking discussion fails to address what anyone with specific investing goals should do with the stock picks. One set of picks is not really meaningful for people with very different needs.

The second issue is that of which stock-picker -- and which stock picks -- to follow. Of the many contests, columns and conferences cranked out each year, which one is worth consuming? For a while, the Ira Sohn annual conference was a hot ticket (and the money raised went to a good cause, too). But alas, aside from a few great selections, the stock-picking prowess of the hedge-fund rock stars for the most part underperformed the benchmarks.

If you're of a certain age, you might remember the Beardstown Ladies investment club. This group of 70-somethings advocated a value-based stock picking approach that racked up spectacular annual returns of 23.4 percent since inception versus a 14 percent return for the Standard & Poor's 500 Index over the same period. That’s fantastic! Only it wasn’t. Anyone who followed their stock-picking acumen was disappointed after an audit revealed a calculation error -- the club had included membership fees in the return calculations. The actual annual returns were 9.1 percent, a third lower than the S&P 500.

So how could these stock-picking exercises be made more useful to investors? There are at least three aspects of stock selection that are usually given short shrift in these contests:

• Process: How are the stocks chosen? What methodologies do the managers use and why? An explanation of this key aspect could be extremely useful to amateur investors.  

• Future liabilities: How does any single selection help manage a future liability (such as retirement expenses in 2039); matching portfolio holdings to a future need would certainly be useful for investors saving for a specific event.

• Portfolio construction: Stocks don't go into a void after being picked; they become part of a larger set of holdings. Suggesting how one can balance various risks, geography, capitalization size, industries and so on when selecting individual companies would be a help.

The focus on these issues would really be doing a service for readers. Meantime, you can check back here next year to see how 2019’s crop of stock pick-a-thons did. My bet? Neither well nor useful.

When David Einhorn discussed shorting Lehman Brothers at the Sohn conference in 2008, it was a great call, garnering a 100 percent return on investment, as Lehman’s subsequently fell from the $40s to zero. But it was one of many stock calls from people who had made other good calls. Which one to pick? Selecting one or two calls out of dozens is a crapshoot; picking them all usually leads to subpar performance.

By the time the error was revealed by the Chicago Tribune, the group had sold more thana million books to unsuspecting investors. You can pick up the 1996 bestseller "The Beardstown Ladies' Common-Sense Investment Guide: How We Beat the Stock Market - And How You Can Too." You can get it for less $1 on Amazon.com.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Barry Ritholtz is a Bloomberg Opinion columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He is the author of “Bailout Nation.”

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