Wednesday, May 20, 2009

Do Jim Cramer Stock Picks Beat the Market?

Posted on the Wall Street Journal MarketBeat by Matt Phillips:

The hooting and hollering that accompanies Jim Cramer’s nightly stock picks on CNBC’s “Mad Money,” have drawn disapproval from a broad range of critics, from dour financial types to spoof-news anchor Jon Stewart, who famously dressed down Cramer back in March.

But beyond matters of style, many have wondered whether Cramer’s stock picks actually pan out. A newly published study by two Northeastern University finance professors set out to find an answer by looking at a dollar-weighted portfolio of recommended stocks. The professors — Paul J. Bolster and Emery A. Trahan — spell out the bottom line:

The cumulative return for this portfolio for the entire period is 31.75%, or an annualized return of 12.09%. The progression of returns for the portfolio and the S&P 500 index is shown in Figure 2. The S&P 500 earned 18.72%, or 7.35% annualized over the same period. The Russell 1000 Growth and Value indexes earned 24.54% (9.51% annualized) and 24.77% (9.59% annualized), respectively. The Russell 2000 Growth and Value indexes earned 22.51% (8.76% annualized) and 9.39% (3.78% annualized), respectively. Thus, the Cramer portfolio outperformed all of these benchmarks.

Even so, the academics explain that their analysis “suggests that Cramer’s portfolio returns are driven by beta exposure, smaller stocks, value-oriented stocks, and momentum effects.” Huh?

In a quick chat with MarketBeat one of the paper’s authors, Paul Bolster, was kind enough to translate, explaining that Cramer beats the market in part because of the excess risk in his picks. “If we adjust for his market risk, we come up with an excess return that is essentially zero,” Bolster said, adding that “zero,” in this case, means his returns are roughly in line with the risk he’s taking on. “He’s pulling his own weight with respect to the risks that his picks represent,” Bolster said. In the paper, Bolster and fellow finance professor Trahan conclude that “we find inconsistent evidence of Cramer’s ability to add value through security selection.”

There has been a lot of interest over the last few years in trying to figure out exactly how much stock-picking skill Cramer actually has. For his part he noted in a 2007 article in New York magazine that “my most recent internal performance review found that the stocks I pick for the show beat the S&P 500 63 percent of the time.”

In August of that year, Barron’s published a piece that attempted to get a fix on exactly how the Cramer’s picks fare. (It turns out that there seemed to be some debate over exactly what qualifies as one of his picks, centering on whether to include calls from the “Lightning Round” segment of the show where he fields questions about company shares on the fly.)

Numbers wonk Patrick Burns served as the key stat cruncher for the Barron’s story, and here’s his paper explaining his approach. Conclusion: “In my opinion, Jim Cramer’s stock-picking superiority is at best unproved.”

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