Why analysts fail
Posted on March 18, 2009 by Richard Beddard
Filed Under Investing |
Parroting Piotroski
The more I read it, the more I think Joseph Piotroski’s 2002 paper on value investing is the best summary of value investing, although it’s a little technical.
It marries measures of value to measures of financial strength to identify companies that aren’t just cheap, but good too.
It explains why small cheap companies beat the market, and why analysts don’t follow them, when you might expect them to.
Here’s one of the reasons:
Ironically, as an investment strategy, analysts do not recommend high BM firms [Book to market. A high book to market ratio is the same as a low price to book ratio and another way of saying a company is cheap or good value] when forming their buy/sell recommendations (Stickel 1998). One potential explanation for this behavior is that, on an individual stock basis, the typical value firm will underperform the market and analysts recognize that the strategy relies on purchasing a complete portfolio of high BM firms.
Piotroski found that value stocks as a group beat the market over a two-year period, but individually only 44% of value stocks are relative winners. Although that seems like a contradiction, it’s easy to explain. The minority of stocks that beat the market recover so strongly they beat it easily, more than making up for losses in the portfolio.
Now put yourself in the position of a stockpicker whose reputation depends on the success of your individual picks. Value investing might be the most profitable strategy, but, if you’re recommending individual companies, it’s not going to get you far unless you have a way of discriminating between good value stocks and bad value stocks.
That was Piotroski’s project, and it culminated in the F_Score.
Category: Investing
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