When Buy Means Sell

by Eric Shkolnik

Overview

Proven strategies for knowing which stock analysts to believe, which to ignore­­and when to sell

Investors are tired of losing money to the bad calls and noncalls of Wall Street analysts, especially on the heels of Enron and other "surprise" stock meltdowns. Instead of giving up, When Buy Means Sell presents an innovative, market-tested system for knowing which recommendations to trust, sniffing out conflicts of interest, and making buy and sell decisions based on valuable, impartial information.

The first fresh approach to this age-old problem, When Buy Means Sell shows investors how to make sense of­­and profit from­­what Wall Street analysts are really saying, by revealing:

• Who the real prophets are­­from individual stars to leading firms
• How to read analyst calls like an insider
• Where to find the truly valuable information

Product Details

ISBN-13:	9780071415651
Publisher:	McGraw Hill LLC
Publication date:	09/22/2002
Sold by:	Barnes & Noble
Format:	eBook
Pages:	256
File size:	4 MB

About the Author

Eric Shkolnik (New York, NY) is CEO and cofounder of marketperform.com, a pioneer service that measures the performance of finsancial institution stock recommendations. Shkolnik and the firm have been featured in Business-Week and Hedge World, and on Bloomberg and TheStreet.com.

Read an Excerpt

Chapter 1

Lessons from Corporate America

Before we begin our journey we should differentiate speculators from investors. Typically speculators are gamblers. They approach the stock market like trips to the casino. Often relying on the roll of the die instead of conducting appropriate due diligence. Occasionally they win, but since these triumphs are simply instances of lucky draws they always interpret them incorrectly. The longer speculators play the market the more chances that they will lose it all. Many unseasoned stock market participants begin their investment journeys as speculators. I was certainly a speculator before becoming an investor. Some eventually will evolve into investors while others will continue not for long to practice speculation. Unavoidably speculators lose on the stock market just like gamblers lose in casinos. Investors approach stock market like a business endeavor. By controlling their impulses and instead focusing on data, fundamentals and value they inevitably succeed. Since our approach to investing will resemble a business process and not speculation lets examine how the worlds most successful companies run their business and why they continue to succeed.

Research, Analysis, and Segmentation of Data

In July 1987 I started working as a programmer analyst with Chase Manhattan Bank. My department at the bank was called Credit Risk Management or, as we were better known internally, the CRM Group. The group was fairly small, roughly a dozen people; however, two and a half years later the group expanded to include 45 employees. This should be an indication of the importance our group had during those tenuous years for the banking industry and the economy as a whole. Downsizing was the business practice of the moment, but our group expanded by almost 400 percent. Many of the employees in this department had received their masters and doctorates in economics and statistics. Their assignment was to regularly monitor and examine the bank's credit card customer portfolio.

My job was to enhance and maintain a system that almost everyone in CRM used to make major credit card policy decisions. This system helped the bank decide who should receive a credit card from Chase and who should not. The system was called the portfolio monitoring system.

There I witnessed for the first time how large corporations use information about their clients and apply it to further their understanding of people's psychology. Today, there are fancy names for this technique such as data mining, business intelligence, and what have you. For our business purposes, we were monitoring our customers' spending patterns and their ability to pay for purchases. If Chase Manhattan Bank ever solicited you for a new Visa or MasterCard, chances are your credit characteristics at one of the credit bureaus resembled the characteristics of a profitable credit card holder. This was a credit card holder who was paying his or her bills on time and, better yet, was habitually paying the minimum amount required.

Similarly, Investors Who Take Advantage of Margin Accounts Are Most Desirable to a Brokerage House In the next chapter, we will discuss margin accounts and why individual investors are better off avoiding them. They are the same reasons individuals should not pay just the minimum amount due on their credit card statements, bringing the overall cost of the purchase to another level.

The system we operated at Chase was very complex and produced a variety of reports for our senior management to scrutinize. Bar charts, line charts, and pie charts were plotted in vibrant colors to show various patterns that our portfolio of credit card customers exhibited. We knew if the number of customers who were not paying their bills was growing or shrinking. We knew if bankruptcies were on the rise or on the decline. Portfolio Monitoring System was like a hawk in flight, observing everyone and everything, which in turn gave our organization the ability to identify characteristics that our customers shared, which ones were fruitful, and those that were not. To succeed as an investor one must learn how to identify characteristics of good and bad companies as well.

Three to four times a year, the bank would embark on what was called a solicitation campaign. CRM would specify a set of traits that potential new customers must have for the bank to consider them for a credit card issue. We would then go to a credit bureau and ask them to run our selection criteria through their database. Those people who passed our standards were supplied with a letter inviting them to become our "most valued" customer. Different products were offered to different people. Some were eligible for a Visa, and others got a MasterCard. Some were offered better interest rates and/or frequent flier miles with their purchases. All the data were then thrown into the Portfolio Monitoring System to help us figure out how successful we were with our solicitations and how we could improve results even more for our next solicitation.

It helped us identify trends and formulate guiding principles for our policymakers. As a straightforward example, Portfolio Monitoring System would divide the portfolio into customers with one credit card in one segment, two credit cards in another segment, three in the next one, and so on. The patterns revealed were stunning. The more credit cards an individual held, the more likely he or she was to default on payment. This example illustrates a simple pattern teaching us, the creditor, to respond accordingly. If people have 10 credit cards in their wallet, let someone else give them another card. We, on the other hand, will look elsewhere; we should look for customers who only have one credit card or a maximum of two. From investors point of view a similar conclusion can be derived. For example, if a company began to aggressively pursue mergers and acquisitions let someone else buy their stock we on the other hand should stay away. By recognizing patterns we were able to increase our ability to recognize people we considered to be "better" potential cardholders and reduce those who were more prone to bankruptcy, late payments, or nonpayment.

Let's not forget why successful companies stay successful. Their profits frequently grow due to their insatiable appetite to learn and their indisputable ability to know the habits of their existing customers, their marketplace, and their competitors. In their drive to succeed and not fall behind their competition, companies are always working on developing new solutions, testing them, and implementing them. It could be effected via a solicitation campaign using direct mail, such as the ones credit card companies send out, or through an ad campaign as seen on television, magazines, billboards, and so on. There is a multitude of avenues available to large corporations for product distribution and analysis. They study what consumers purchase and what they leave on the shelf. They continuously examine facets of their existing customers, such as money-spending patterns, how they come to be customers, and why some left to do business with our competitors. Investors need to follow the same principles. Understanding why certain stocks were a good investment and others were not is crucial.

Personally, the most enjoyable and valuable lesson learned while working for corporate America was my realization of how consistent and determined these companies are to improve their knowledge and understanding of the consumer and how willing they are to risk a portion of their pie customers or profits in exchange for innovative ideas.

Champions and Challengers

Champions and Challengers are a money collection system that worked extremely well at Chase. Everyone knows how difficult it can be to collect money from habitual debtors. Needless to say, Chase, like any other creditor, wanted to see its money returned. To accomplish this, they have set up the Champion and Challenger system, which worked like this: Of all the defaulted accounts, 80 percent were turned over to the collection department that yielded the highest results in the previous year(s). This outperforming department was obviously employing the best strategy for collecting debt and, therefore, was known as the "champion." The remaining 20 percent of outstanding accounts were split evenly between two other collection departments that utilized two different collection strategies. They in turn were called "challenger I" and "challenger II." If by following a different (new) system, one of the challengers performed better than the champion, this challenger was promoted to the rank of the new champion until it was outperformed by a different collection strategy. If this was the case, this new top-performing challenger became the new champion and so on. Thus, the collection system with the best track record always became the new champion and retained its title until a different collection system prevailed. This rotating system of champions and challengers that encourages competition and, consequently, progress has a wide range of application in the investing arena.

Can we apply this collection system to our investment needs? Let's examine a hypothetical situation: It is 1992 and our asset management department was just entrusted with $1 million to invest in equity based mutual funds. There is only one conditional stipulation from the people who have assigned to us this awesome responsibility: Do not under-perform the market, which for the sake of comparison is the S&P 500 Index. It sounds easy. However, after investigating and examining the performance of all mutual funds out there, we found that 80 percent show a tendency to under-perform the S&P 500. The 20 percent that outperform the index during any given year in most cases fail to fulfill this objective in the following year. That is, research showed that mutual funds either do worse than the market, or if they manage to beat the market, they cannot sustain their momentum.

Investing all the money into an index fund that tracks the S&P 500 will not justify our job. This can be done without the help of an asset management team. Therefore, our team decided to do the following: invest $800,000 of the available capital into the best performing system, the champion. Thus, we have picked the Vanguard S&P 500 Index Fund, which tracks the performance of the S&P 500 Index (VFINX). As we have said, it managed to outperform 80 percent of all actively managed mutual funds throughout its history. The remaining 20 percent, or $200,000, was divided between two different mutual funds, our challenger I and challenger II. For the sake of our demonstration, we chose the American Heritage Fund (AHERX) to represent the first challenger. In 1990 Heiko Theime, the fund's manager, caught investors' interest with an eye-catching return of more than 96 percent. This fund, by the way, proved to be one of the worst performing mutual funds ever.

As challenger II we stopped our search on a more conservative Legg Mason Value Prime Fund (LMVTX), which beat the S&P 500 in 1990 by a modest 33 percent. This fund, by the way, proved to be one of the best performing mutual funds ever.

After 5 years on the job, we are ready to show the results to our investors. Figure 1-1 is what our "report card" looked like for 1992 through 1996.

Comp: TCH in cols. 3, 4, 5 below should set on 2 lines: don't break "Champion" and don't put "I" and "II" on separate lines

Figure 1-1

Champion-Challenger scenario with VFINX as champion.

Year S&P 500 Index VFINX

Champion AHERX

Challenger I LMVTX

Challenger II Total Investment Results for the Year (using 80/10/10 split)

1992 5.18% 8.07% 14.33% 12.11% 9.10%

1993 6.30% 9.12% 39.29% 11.48% 12.37%

1994 21.54% 1.20% 236.90% 1.33% 22.60%

1995 34.11% 37.45% 230.59% 40.84% 30.99%

1996 22.32% 22.81% 26.76% 38.20% 21.39%

Total 5-year return 66.37% 78.65% 220.63% 103.96% 71.25%

Our total return for 1992 to 1996, inclusively, produced a respectable 71.25 percent return, whereas the S&P 500 produced 66.37 percent. Not bad, considering our hypothetical asset manager spent only a few hours researching the mutual fund industry's performance over the last 5 years. As the table demonstrates, we were triumphant, outperforming the market by almost 5 percent. Nonetheless, we realized that there was room for improvement. A mutual fund that is not sufficiently diversified, as was the case with AHERX, can be a sinker. Thus, we've learned our lesson and decided that challenger I, occupied by Mr. Heiko's American Heritage Fund, should take a hike and be replaced with a new challenger. In addition we noticed that challenger II, occupied by the Legg Mason Value Prime Fund, produced better results than the current champion.

What should our next logical step be? According to our champion-challenger theory, the reigning champion should be deposed, and the challenger that outperformed the competition should be crowned as the new monarch. It is a simple rule of capitalism, or as communists would call it the jungle market mentality, where the strongest survive while the weak fall into oblivion.

Our job as money managers is not over, however. On the contrary, we've just crowned a new champion, Legg Mason Value Prime, which has proven to have a better performing system for picking stocks and which will be assigned 80 percent of the capital. Now we must immediately start thinking of finding new challengers to whom we will assign the rest of the business with 10 percent for each new mutual fund. As an investor or businessperson, you should never be lulled into a false sense of security. Perhaps you are satisfied with the new money management system that gets you market-beating results; however, you cannot stop here. As soon as you relax and stop innovating, someone else will think of a way to do it better and put you out of business.

To further illustrate how our strategy works, over the next 5 years our strategy may have been as follows. Challenger II, Legg Mason Value Prime Fund, became our new champion attracting 80 percent of our capital. Challenger I was designated to carry a new mutual fund. Suppose we chose Fidelity Select Electronics (FSELX). The decision was based on its prior 5-year performance. The managers at this Fidelity fund produced stunning results. From 1992 through 1996, they outperformed the S&P 500 Index every year. In fact FSELX produced better results than our best performing fund, our new champion, LMVTX. For Challenger II we selected the top-notch performer: Growth Fund of America (AGTHX). This fund had very solid returns as well. For the period 1992 to1996, it managed to outperform the S&P 500 Index on four of five occasions. Results for the aforementioned mutual funds as applied to our investment strategy appear in Figure 1-2.

Table of Contents

	Acknowledgments	v
	Introduction	1
Chapter 1	Lessons from Corporate America	15
Chapter 2	Rules of Engagement	25
Chapter 3	Media and the Investor	43
Chapter 4	Who Are the Analysts?	59
Chapter 5	Types of Analysis: Fundamental Versus Technical	79
Chapter 6	The Food Chain of Capital Markets	111
Chapter 7	Broker Versus Mouse Click: The Evolution of Trading	131
Chapter 8	Reputation, Trust, and Statistical Vengeance: Trust but Verify	145
Chapter 9	When "Sell" Really Means "Buy"	169
Chapter 10	Statistics, Probability, Chance, and Uncertainty	185
Chapter 11	Taking Advantage of Regression to the Mean	199
Appendix	The Marketperform.com System	215
	Index	223