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    Should You Seek or Shun the Most Popular Stocks?

    by Mark Hulbert

    Popularity is one of those traits whose desirability in the investment arena is difficult to assess without a cold hard look at the facts.

    On the one hand, some believe that a stock’s popularity is a good thing, on the theory that whatever factors have convinced so many advisers to recommend a particular stock should make it a better bet than the stocks that no one is recommending.

    On the other hand, contrarians argue that popular stocks should be avoided; if given a choice between two stocks with similar financials, they would prefer the less-popular one, on the assumption that it has not yet been discovered. Of course, often there are no such clear-cut choices.

    Which “popularity” theory is right?

    Fortunately, we don’t have to answer this question through reasoning alone—enough data exist to provide a conclusive answer, at least as it pertains to popularity in the newsletter arena. That’s because the Hulbert Financial Digest (HFD) has been tracking the performance of investment newsletters for 25 years.

    What I found upon analyzing the HFD’s database is somewhere in between the extremes formed by both sides in this debate. A sneak preview of my conclusion: While you should not automatically avoid newsletters’ most popular stocks, they will be most attractive to only certain types of investors—and, even then, only in certain circumstances.

    The HFD Study

    Here’s how I went about measuring the performance of newsletters’ most popular stocks. For the last trading day of each month from mid-1980 through April of this year, I obtained the five stocks that were at that time the most recommended among all newsletters I track. If there was a tie among several stocks for being fifth most popular, all stocks tied for fifth-place were included. The resultant database of popular stocks contained 2,039 issues, spanning nearly 25 years.

    For each of these stocks, I compared its total return to that of the Wilshire 5000 over both the month and 12 months following the effective date at which the stock made it into this database. Finally, I averaged those relative performances across the entire database.

    On average over the nearly 25 years since mid-1980, I found:

    • Over the month following the date on which they became the most popular, the newsletters’ most popular stocks on average did 0.12% (12 basis points) better than the Wilshire 5000;

    • Over the subsequent 12 months after they became most popular, these stocks on average did 0.96% (96 basis points) better than the Wilshire 5000.

    Implications

    What conclusions can investors draw from these results?

    On the one hand, because the newsletters’ most popular stocks did outperform the market, the contrarians are wrong about them.

    On the other hand, the amount by which the average popular stock outperformed the Wilshire 5000 index is probably not enough to overcome the transaction costs associated with a strategy that buys and sells stocks solely on the basis of their popularity among newsletters.

    That doesn’t, however, mean that newsletter popularity should be ignored.

    For example, it may be that you have already decided, for completely different reasons, to either increase or decrease your exposure to the stock market. In that event, you will be paying transaction costs anyway. If so, then the pre-transaction-cost performance numbers are the appropriate ones on which you should focus when deciding whether some stocks are more or less deserving of being bought or sold. However, to find any more profound investment implications than these, we’re going to have to dig deeper.

    Figure 1.
    Newsletters' Most Popular Stocks:
    Performance Relative to the Wilshire 5000
    CLICK ON IMAGE TO
    SEE FULL SIZE.

    My first step in digging deeper was to ask: “What kind of stock is typically most popular among newsletters?” Figure 1 provides some clues: It shows the performance of the most popular stocks relative to the Wilshire 5000 for each year. Notice that newsletters’ most popular stocks performed particularly well in the decade of the 1990s. Over the 10 years from 1990 through 1999, for example, there was only one year in which, on average, newsletters’ most popular stocks lagged the Wilshire. Furthermore, the extent of outperformance was substantial: In two years—1996 and 1998—popular newsletter stocks, on average, outperformed the Wilshire by was at least 20% on an annualized basis.

    By the same token, notice that newsletters’ most popular stocks have performed disastrously during the current decade. Beginning with calendar year 2000, there has been only one year in which the average of such stocks beat the Wilshire 5000—year 2002—and even then the average outperformance was just 1% on an annualized basis. Furthermore, the magnitude of the losses was substantial. The average stock that became popular in 2000, for example, lagged the Wilshire 5000 by more than 40% over the 12 months after becoming most popular.

    This pattern gives us a clue about the kind of stocks that newsletters like the most. The decade of the 1990s was characterized, among other things, by the tendency for growth stocks to outperform value stocks. The current decade, in contrast, has been just the opposite.

    To test this hunch, I compared newsletters’ most popular stocks to the performance of small-cap and large-cap stocks, and to that of growth and value stocks. (I relied on the performance data for the various styles as calculated by finance professors Eugene Fama of the University of Chicago and Kenneth French of Dartmouth.) As expected, I found that the typical stock on the list of newsletters’ most popular stocks is heavily skewed toward the growth end of the value-growth spectrum, and it is skewed toward the large-cap end of the size spectrum. In other words, the most popular stocks tend to be large-cap growth stocks.

    These findings help to explain the big reversal shown in Figure 1. It’s not that newsletter popularity underwent a transformation from being very valuable to being worse than useless. The correct interpretation, in my opinion, is that the sector from which newsletters’ most popular stocks tend to come—large-cap growth stocks—itself went from being a market leader to a huge market laggard.

    Further evidence for this comes from how the average stock on the list of newsletters’ most popular performs relative to a hypothetical stock that is at the same place on the spectrums of value-vs.-growth and large-vs.-small. There is not much of a difference between the pre-2000 and post-2000 periods.

    The Bottom Line

    These findings suggest that a list of newsletters’ most popular stocks is most relevant to an investor who already has decided to invest in the large-cap growth sector of the market. Such an investor will be incurring transaction costs anyway, and will be subjecting himself to the whims of that sector.

    In that spirit, Table 1 lists the stocks that currently are the most popular among the 183 newsletters on the HFD’s monitored list.

    TABLE 1. Stocks with the Most Current Purchase Recommendations Among Newsletters
    Ticker (Exch) Name Noof
    Recomm
    P/E
    Ratio
    (X)
    5-Yr
    EPS
    Growth
    (%)
    52-Wk
    Rel Strgth
    Index*
    (%)
    Market
    Cap
    ($ Bil)
    PFE (N) Pfizer 17 22.7 13.3 -26.0 207.1
    NEM (N) Newmont Mining 13 35.7 29.3 -9.0 15.7
    JNJ (N) Johnson & Johnson 13 22.6 15.0 17.0 199.5
    INTC (M) Intel Corporation 12 20.1 1.2 -12.0 155.1
    BRK B (N) Berkshire Hathaway 11 17.9 35.9 -9.0 127.8
    HD (N) The Home Depot 11 16.1 17.1 2.0 78.3
    GE (N) General Electric Co 10 22.0 8.2 12.0 378.6
    C (N) Citigroup 10 14.8 8.3 -5.0 238.8
    BAC (N) Bank Of America 10 11.5 10.5 7.0 181.5
    PEP (N) PepsiCo 10 22.7 11.9 0.0 94.5
    AET (N) Aetna Inc 10 17.5 25.5 75.0 21.5
    UNH (N) UnitedHealth Group 10 22.5 38.2 45.0 60.4


    Mark Hulbert is editor of the Hulbert Financial Digest, a newsletter that ranks the performance of investment advisory newsletters. It is published monthly and is located at 5051B Backlick Rd., Annandale, Va. 22003; 703/750-9060; www.hulbertdigest.com. This column appears quarterly and is copyrighted by HFD and AAII.


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