Is Stock Picking A Myth?

Year after year it gets harder for mutual funds to beat the index. It seems like the top stock pickers hit high marks one year then fade to mediocrity the next. With the high fees associated with mutual fund management, and some of the largest funds consistently underperforming the market, you have to question whether mutual fund managers can really pick stocks. For those who invest in mutual funds, it's a very good question: If, over time, mutual fund managers can successfully pick stocks then the price of active management is worthwhile; if not, index funds are the best bet.

SEE: Efficient Market Hypothesis: Is The Stock Market Efficient?

Picking Stocks in an Efficient Market
For anyone who has taken Finance 101, you may recall the efficient market hypothesis (EMH). Eugene Fama from the University of Chicago presented his argument in the early part of the 1960s that the financial markets are or can be very efficient. The concept implies that market participants are sophisticated, informed and act only on available information. Since everyone has the same access to that information, all securities are appropriately priced at any given time. This theory does not necessarily negate the concept of stock picking, but it s call into question the viability of consistent abilities to outperform the market by exploiting information that may not be fully reflected in the price of a security.

For example, if a portfolio manager purchases a security, he or she believes that it is worth more than the price paid now or in the future. In order to purchase that security with a finite amount of money, the portfolio manager will also need to sell a security that he or she believes is worth less now or in the future, again exploiting information that has not been reflected in the price of the stock. The concept of efficient market theories was expanded upon in a short book, which is now a staple for those who study finance, "A Random Walk Down Wall Street" by Burton Malkiel.

It is taught that the EMH comes in three distinct forms: weak, semi-strong and strong. Weak theory implies that current prices are based accurately on historical prices; semi-strong implies that current prices are an accurate reflection of financial data available to investors; and strong form is the most robust form, implying that all information has basically been included in the price of a security. If you follow the first form, you are more likely to believe that technical analysis is of little or no use; the second form implies that you can toss your fundamental security evaluation techniques away; if you subscribe to the strong form, you may as well keep your money under your mattress.

SEE: Financial Concepts Tutorial

Markets In Reality
While it is important to study the theories of efficiency and review the empirical studies that lend creditability, in reality, markets are full of inefficiencies. One reason for the inefficiencies is the fact that every investor has a unique investment style and ways of evaluating an investment. One may use technical strategies while others rely on fundamentals, and still others may resort to using a dartboard. There are also many other factors that influence the price of investments, from emotional attachment, rumors, the price of the security, and good old supply and demand. Part of the reason Sarbanes-Oxley Act of 2002 was implemented was to move the markets to greater levels of efficiency because the access to information for certain parties was not being fairly disseminated. It's hard to say how effective this was, but at least it made people aware and accountable.

While EMH does imply that there are few opportunities to exploit information, it does not rule out the theory that managers can beat the market by taking some extra risk. Most contemporary stock pickers fall in the middle of the road; although they believe that most investors have the same access to information, the interpretation and implementation of that data is where a stock picker can add some value.

Stock Pickers
The process of stock picking is based on the strategy an analyst uses to determine what stocks to buy or sell and when to buy or sell. Peter Lynch was one of the most famed stock pickers who employed a successful strategy for many years while at Fidelity. While many believe he was a very smart fund manager and topped his peers based on his decisions, the times were also good for stock markets and he had a little luck on his side. While Lynch was primarily a growth style manager, he also used some value techniques blended into his strategy. This is the beauty of stock picking: no two stock pickers are alike. While the racier varieties are in the growth arenas, the variations and combinations are endless and unless they have a strategy that is absolutely written in stone, their criteria and models can change over time.

Does Stock Picking Work?
The best way to answer that question is to evaluate how portfolios managed by stock pickers have performed, and open the debate of active vs. passive management. Depending on what periods you focus on, the S&P 500 typically ranks above the median in the actively managed universe. This means that usually at least half of the active managers fail to beat the market. If you stop right there, it's very easy to conclude that managers cannot pick stocks effectively enough to make the process worthwhile. If that's case, all investments should be placed inside an index fund.

Taking out management fees, transaction costs to trade and the need to hold a cash weighting for day-to-day operations, it's easy to see how the average manager underperformed the general index by those restrictions. The odds were just stacked against them. When all other costs are removed, the race is much closer. In hindsight it would be easy to have suggested investing solely in index funds, but the allure of those high-flying funds are too hard to resist for most investors. Quarter after quarter, money flowed from lower performing funds to the hottest fund from the previous quarter, only to chase the next hottest fund.



Conclusion
The success of stock picking has been hotly debated, and depending on whom you ask, you will get various opinions. There are plenty of academic studies and empirical evidence suggesting that it is difficult to successfully pick stocks to outperform the markets over time. There is also evidence to suggest that passive investing in index funds can beat over half of active managers in many years. The problem with proving successful stock picking abilities is that individual picks become components of total return in any mutual fund. In addition to a manager's best picks, in order to be fully invested, the stock pickers will undoubtedly end up with stocks that he or she may not have picked or needs to own to stay in the popular trends. For the most part, it is human nature to believe that there are at least some inefficiencies in the markets and every year some managers successfully pick stocks and beat the markets. However, few of them do this consistently over time.



More From Investopedia

--

Get stories like this on the Yahoo app and discover more every day.
Download it now.
Loading...
  • Swiss Exchange confident of post-Brexit access to EU stock market
    Swiss Exchange confident of post-Brexit access to EU stock market Reuters - 5 minutes ago

    The SIX Swiss Exchange said on Wednesday it was confident it can continue serving investors in the European Union without having to set up a new exchange after Britain exits the EU. Switzerland is not part of the EU and currently serves customers … More »

  • Tokyo to propose moving more venues for Olympics
    Tokyo to propose moving more venues for Olympics Associated Press - 11 minutes ago

    Tokyo's original plans for a compact Olympics in 2020 continue to fall by the wayside. A Tokyo government panel is set to propose moving more venues outside of the city — including hundreds of kilometers ... … More »

  • SABMiller investors cheer $100 billion-plus AB InBev takeover
    SABMiller investors cheer $100 billion-plus AB InBev takeover Reuters - 17 minutes ago

    LONDON/BRUSSELS (Reuters) - SABMiller (SAB.L) shareholders overwhelmingly backed the brewer's $100 billion-plus takeover by Anheuser-Busch InBev (ABI.BR) on Wednesday, clearing the last big hurdle for one of the largest corporate mergers in history. … More »

  • The Latest: Obama says people don't give Clinton credit
    The Latest: Obama says people don't give Clinton credit Associated Press - 20 minutes ago

    The Latest on the U.S. presidential election (all times EDT): 9:20 a.m. President Barack Obama says people don't give Hillary Clinton enough credit — perhaps partially because she's a woman. Obama was ... … More »

  • Lufthansa board approves takeover of Brussels Airlines
    Lufthansa board approves takeover of Brussels Airlines Reuters - 32 minutes ago

    Lufthansa (LHAG.DE) said its supervisory board has approved plans to acquire the remaining 55-percent stake in Brussels Airlines via the exercise of a call option as part of its plan to boost its low-cost unit Eurowings via acquisitions. The … More »

  • ING selling $300 million Kotak Mahindra stake - term sheet
    ING selling $300 million Kotak Mahindra stake - term sheet Reuters - 33 minutes ago

    Dutch financial services company ING Group is selling a $300 million stake in Indian lender Kotak Mahindra Bank Ltd in a block trade on Thursday, according to a deal term sheet seen by Reuters. The deal has an upsize option of up to $550 million, … More »

  • Credit Suisse CEO says bank relatively well positioned for Brexit
    Credit Suisse CEO says bank relatively well positioned for Brexit Reuters - 35 minutes ago

    Credit Suisse (CSGN.S) Chief Executive Tidjane Thiam said on Wednesday that his bank was relatively well placed to deal with the impact of Britain's vote to leave the European Union. Credit Suisse's EU investment banking business is run out of … More »

  • Oil climbs on hopes of output-limiting deal in November
    Oil climbs on hopes of output-limiting deal in November Reuters - 42 minutes ago

    Oil prices rose on Wednesday, after sharp losses in the previous session, as the focus shifts to a potential output-curbing deal from OPEC later this year and a surprise drawdown in U.S. crude stocks. Brent crude (LCOc1) was up 59 cents to $46.56 a … More »

  • Tie-up of world's biggest beer makers clears final hurdle Associated Press - 46 minutes ago

    A deal worth over $100 billion to combine the world's two biggest beer companies cleared its last major hurdle Wednesday when the shareholders of SABMiller approved the takeover by Budweiser maker Anheuser-Busch ... … More »

  • Pakistan launches $500 million in Islamic bonds AFP - 48 minutes ago

    Pakistan is set to launch $500 million in Islamic bonds to raise money for its foreign exchange reserves, a senior official said Wednesday, as a three-year IMF bailout package nears a close. The government ... … More »

  • Deutsche Bank relief helps European markets regain footing
    Deutsche Bank relief helps European markets regain footing Associated Press - 49 minutes ago

    European stock markets brushed aside a mixed performance in Asia earlier Wednesday to post solid gains amid some relief over the financial future of Germany's largest bank, Deutsche Bank. KEEPING SCORE: ... … More »

  • BlackBerry outsourcing smartphone design in strategic shift; shares up
    BlackBerry outsourcing smartphone design in strategic shift; shares up Reuters - 55 minutes ago

    BlackBerry Ltd will outsource the development and design of its flagship smartphone, an industry it helped pioneer, as it bets its future on software and services, the Canadian technology company said on Wednesday. The new helped send BlackBerry … More »

  • Tribune Media completes sale of Tribune Tower, other assets
    Tribune Media completes sale of Tribune Tower, other assets Associated Press - 3 minutes 31 seconds ago

    Tribune Media has completed the sale of several real estate assets, including the Tribune Tower in Chicago. The Chicago-based company announced last month that it was selling the 1925 neo-Gothic tower ... … More »

  • Germany denies preparing Deutsche Bank rescue plan Reuters - 1 hour 14 minutes ago

    The German government denied it was working on a rescue of Deutsche Bank as Germany's biggest lender boosted its balance sheet by selling its British insurance business on Wednesday. Deutsche is facing a $14 billion fine from the U.S. Department of … More »

  • Owner of Malaysia's Proton shortlists 5 bids for equity sale Associated Press - 1 hour 19 minutes ago

    The owner of Malaysian national carmaker Proton says it has shortlisted five foreign partners for a partnership that includes an equity sale aimed at reviving the loss-making company. Syed Faisal Albar ... … More »

  • Saudis soften oil stance on Iran but OPEC deal still elusive Reuters - 1 hour 20 minutes ago

    OPEC might still agree an oil output-limiting deal later this year as the economic problems of its de-facto leader Saudi Arabia force Riyadh to cede more ground to arch-rival Iran. Saudi Energy Minister Khalid al-Falih said on Tuesday Iran, Nigeria … More »

  • Actuant tops 4Q profit forecasts Associated Press - 1 hour 20 minutes ago

    The Menomonee Falls, Wisconsin-based company said it had profit of 29 cents per share. Earnings, adjusted for one-time gains and costs, came to 30 cents per share. The results beat Wall Street expectations. ... … More »

  • Deutsche helps lift European stocks before Yellen, Draghi
    Deutsche helps lift European stocks before Yellen, Draghi Reuters - 1 hour 31 minutes ago

    By Nigel Stephenson LONDON (Reuters) - A recovery in Deutsche Bank shares helped push European stocks higher on Wednesday, easing concerns over Germany's financial sector that had hit equities in Asia ... … More »

  • Dissident SABMiller shareholder Aberdeen disappointed with vote Reuters - 1 hour 39 minutes ago

    LONDON (Reuters) - Aberdeen Asset Management (ADN.L), an SABMiller (SAB.L) shareholder that opposed the brewer's takeover by Anheuser Busch InBev (ABI.BR), said it was "obviously disappointed by not ... … More »

  • BlackBerry is giving up on making its own phones
    BlackBerry is giving up on making its own phones Business Insider - 1 hour 52 minutes ago

    Reuters John Chen, CEO of BlackBerry. It’s the … Continued The post BlackBerry is giving up on making its own phones appeared first on Business Insider. … More »

  • Deutsche gets lift from $1.2 billion sale of Abbey Life to UK's Phoenix Reuters - 1 hour 53 minutes ago

    Deutsche Bank AG (DBKGn.DE) has sold its British insurance business Abbey Life to Phoenix Group Holdings (PHNX.L) as it sheds non-core assets and reduces its balance sheet in an effort to reassure anxious investors and meet regulators' demands. … More »

  • Russian charged for flying drone over Polish PM's office AFP - 1 hour 54 minutes ago

    Polish prosecutors said on Wednesday they had charged a Russian citizen with violating airspace laws for allegedly flying an unauthorised drone over the prime minister's office in Warsaw. Identified only ... … More »

  • Any ECB scheme to buy stocks could total 200 billion euros - ABN AMRO Reuters - 1 hour 56 minutes ago

    The ECB is widely expected to extend its 1.7 trillion euro (£1.47 trillion) asset purchase programme given still low inflation and tepid economic growth, both of which the programme is designed to combat. In a note, ABN AMRO said the structure used … More »

  • Moldova bans Ukraine meat over African swine fever fears Associated Press - 2 hours 1 minute ago

    Moldovan authorities are banning the import of live animals and meat from Ukraine due to fears of African swine fever. Agriculture Minister Eduard Grama says the ban begins Wednesday after several suspected ... … More »

  • European stocks rebound awaiting OPEC decision
    European stocks rebound awaiting OPEC decision AFP News - 2 hours 2 minutes ago

    European stock markets rebounded on Wednesday, brushing aside a broad retreat across Asia, as investors paid close attention to a meeting of OPEC to tackle a global supply glut. Around 1030 GMT, London's benchmark FTSE 100 index was up 0.7 percent. … More »

 
Recent Quotes
Symbol Price Change % Chg 
Your most recently viewed tickers will automatically show up here if you type a ticker in the "Enter symbol/company" at the bottom of this module.
You need to enable your browser cookies to view your most recent quotes.
 
Sign-in to view quotes in your portfolios.

MARKET MOVERS

  • Most Actives
    Most Actives
    NamePriceChange% Chg
    0.151+0.010+7.09%
    N21.SI
    0.975+0.010+1.04%
    Y92.SI
    0.144+0.002+1.41%
    5DM.SI
    4.00+0.01+0.25%
    Z74.SI
    0.675+0.050+8.00%
    BMT.SI
  • % Gainers
    % Gainers
    NamePriceChange% Chg
    0.37+0.12+45.10%
    AZT.SI
    0.24+0.05+26.32%
    AWI.SI
    0.15+0.02+15.38%
    RF7.SI
    0.215+0.026+13.76%
    I07.SI
    0.13+0.01+8.33%
    5UE.SI
  • % Losers
    % Losers
    NamePriceChange% Chg
    0.112-0.028-20.00%
    BEH.SI
    0.66-0.05-7.04%
    BTE.SI
    0.32-0.02-5.88%
    P9D.SI
    0.225-0.010-4.26%
    PA3.SI
    0.23-0.01-4.17%
    K14.SI

Market Data

  • Currencies
    Currencies
    NamePriceChange% Chg
    1.3599+0.0004+0.03%
    USDSGD=X
    1.5248-0.0001-0.01%
    EURSGD=X
    1.7687-0.0015-0.08%
    GBPSGD=X
    73.8690+0.013+0.02%
    SGDJPY=X
    5.6987-0.0036-0.06%
    SGDHKD=X
    3.0418+0.0028+0.09%
    SGDMYR=X
    9,519.8809-8.5723-0.09%
    SGDIDR=X
    4.9050-0.0005-0.01%
    SGDCNY=X
    1.0428+0.0006+0.06%
    AUDSGD=X
  • Commodities
    Commodities
    NamePriceChange% Chg
    1,326.20-4.20-0.32%
    GCZ16.CMX
    19.10-0.06-0.31%
    SIZ16.CMX
    93.52+0.54+0.58%
    ^XAU
    2.19+0.02+0.78%
    HGZ16.CMX
    43.85+0.41+0.94%
    CLV16.NYM
  • Bonds
    Bonds
    TreasuryYield (%)Yield Change
    1.12-0.01
    ^FVX
    1.56-0.03
    ^TNX
    2.29-0.04
    ^TYX