Are preferred stocks more or less risky than convertible preferred stock?

Stock Market --- When Good Stocks Go Bad (Reposted Question for More Money)

• Hi There ! I have reposted this question for more money. The original question brought some fantastic comments from rabaga, neilzero, hailstorm, and and the grammatoncleric. I really appreciate their insights! But this is an important research project, so I am still looking. Below is the question. Thanks in advance. ***************************************************************** I am trying to find some data I read about a few weeks ago. Apparently, a finance professor simulated buying 200 stocks. All 200 were chosen at random (i.e., by throwing darts at a dart board). Any stock which declined 5% or more from the purchase price was "sold" from the portfolio. All the remaining stocks (in the range from minus 4.99% to plus 100%) were retained in the portfolio. The portfolio apparently did very well, beating the S&P 500 year after year. The professor's point was this: it doesn't matter how you pick stocks. It only matters that you sell losers and keep winners. This "simpleton" approach sounds too good to be true. On the other hand, this approach is intriguing given many investors refuse to sell losing stocks while those stocks are still down. In my own experience, a single badly-decayed stock can overwhelm an entire portfolio of good stocks. A 5-star answer would be finding this study (or two studies similar to it) which discusses "money management" rules as opposed to "stock picking" rules. All comments greatly appreciated! Thanks. ron

• Answer:

  Thanks for asking (again), Ron! Let's start with.... A Bit of Dartboarding History ---------------------------------------------------------------------- The "father" of the Dartboard model is William F. Sharpe, Nobel Laureate in Economic Sciences, 1990, for work based upon his 1964 essay, "The Capital Asset Pricing Model, or Risk/Return Model". "Modern Portfolio Theory was not yet adolescent in 1960 when William F. Sharpe, a 26-year-old researcher at the RAND Corporation, a think tank in Los Angeles, introduced himself to a fellow economist named Harry Markowitz. Neither of them knew it then, but that casual knock on Markowitz's office door would forever change how investors valued securities." The full article: Revisiting The Capital Asset Pricing Model, by Jonathan Burton http://www.stanford.edu/%7Ewfsharpe/art/djam/djam.htm Sharpe's Articles, Papers, Talks and Cases Available for Direct Viewing: William F. Sharpe Papers and Articles http://www.stanford.edu/%7Ewfsharpe/art/art.htm Another well-known contribution in the field is "A Random Walk down Wall Street", by Princeton University Professor Burton G. Malkiel. "The basic random walk premise is that price movements are totally random. Judging from the chart, the price movements of Newmont Mining over this 5-month period would appear to be quite random. Prices have no memory, therefore past and present prices cannot be used to predict future prices (as implied in technical analysis). Prices move at random and adjust to new information as it comes available. The adjustment to this new information is so fast that it is impossible to profit from it. Furthermore, news and events are also random and trying to predict these (fundamental analysis) is also a lesson in futility." A Random Walk | ChartSchool http://www.stockcharts.com/education/Overview/randomWalk.html This work spawned the famous Wall Street Journal Dartboard Contest. "In 1988 the Wall Street Journal began a contest that was inspired by Burton Malkiel's book A Random Walk Down Wall Street. In the book, the Princeton Professor theorized that "a blindfolded monkey throwing darts at a newspapers financial pages could select a portfolio that would do just as well as one carefully selected by experts." The Journal set out to create an entertaining contest to test Malkiel's theory and give its readers some new investment ideas in the process. Wall Street Journal staff members typically play the role of the monkeys (the Journal listed liability insurance as one reason for not going all the way and actually using live monkeys)." The Wall Street Journal Dartboard Contest http://www.investorhome.com/darts.htm "The idea Prof. Malkiel was explaining is known as the "efficient-market theory." The theory holds that all available information is quickly reflected in stock prices, and so all stocks present equal chances for a gain." A Brief History of our Contest (A quick, entertaining read ---l) http://update.wsj.com/public/current/articles/SB907719524729880000.htm And finally, the recent studies, In 1995, the following study was published in the Journal Of Financial And Strategic Decisions: THE PERFORMANCE OF STOCKS: PROFESSIONAL VERSUS DARTBOARD PICKS ---------------------------------------------------------------------- "This paper evaluates the performance of a portfolio formed on professional advice (also called pros picks) with another portfolio picked at random (also called random or dart picks). We study public announcements of professionals recommendations and random picks from the ?Investment Dartboard? column in the Wall Street Journal. Our findings indicate that significant abnormal returns accrue to the investors of pros picks, on the day of publication and on one day after the publication. The results also indicate that there is no significant stock price behavior pattern prior to the pros recommendation. The holding period is arranged on a continuum ranging from roughly one week to six months and a comparison of the mean excess returns of the two portfolios is made over this range. Results suggest that the pros selection statistically outperforms the random selection only in the one-week period. Over a six-month holding period, the random stocks perform better than the pros recommendations. A publicity effect is discerned from the pros recommendation, which gives support to a moral hazard problem encountered by investment professionals. The results are also consistent with the literature on noise and overreaction." Journal Of Financial And Strategic Decisions, Volume 8 Number 1 Spring 1995 Youguo Liang, Sanjay Ramchander and Jandhyala L. Sharma The Performance of Stocks: Professional Versus Dartboard Picks The contrarian viewpoint is expressed by Randall A. Heron, Glen A. Larsen, Jr., and Bruce G. Resnick, of Indiana and Wake Forest Universities, in "The Improper Use of Dartboard Portfolios as Performance Benchmarks". "In this paper we empirically study the improper use of dartboard portfolios (i.e., randomly selected portfolios of stocks) as ?passive? investment performance benchmarks for active financial decision-making investment strategies. The problems associated with dartboard benchmark portfolios arise because of systematic risk differences, price pressures, and benchmarking errors. Simulations show that dartboard portfolios are, in terms of risk-adjusted performance, dominated by the broader market index fund constructed from the universe of stocks from which the dartboard portfolios are selected. The dartboard portfolios suffer from the lack of diversification due to size and errors in security selection. The dominance of the index fund persists even when we employ Markowitz optimization techniques to identify ex ante efficiently diversified portfolios of the randomly selected stocks." The Improper Use of Dartboard Portfolios as Performance Benchmarks http://www.financialdecisionsonline.org/current/heron.pdf An off-the-cuff resource: Money, Money, Money (and Investing) by Philip Greenspun "Common Stocks and the Efficient Market Hypothesis Suppose somehow that you collect a non-negligible amount of cash and want to invest it. If you are investing for the long-haul, then common stocks are your only reasonable choice since they offer the best return. According to the Efficient Market Hypothesis, all stocks are fairly valued because everyone on Wall Street has the same information. So unless you have friends who will give you insider information, there is no reason that you should buy Microsoft rather than General Motors. Sure, Microsoft has a monopoly and GM doesn't, but Microsoft's monopoly is already reflected in their lofty price/earnings ratio and GM's perennial engineering and management problems are already reflected in their absurdly low price/revenue ratio. If you buy into the Efficient Market Hypothesis then you're just as happy to buy a portfolio of stocks selected by throwing darts at the inside pages of the Wall Street Journal. In fact, the WSJ for many years pitted expert wall street analysts against a dartboard portfolio and the darts almost always did better. If you don't have very much money, then a problem with a dartboard portfolio is that you will only be able to buy a few stocks. Your expected return will still be 7 percent per year but the variance will be extremely high because one company going bust could wipe out all of your gains." Money, Money, Money http://philip.greenspun.com/materialism/money I hope you find the information useful. Feel free to ask for clarification if anything is unclear/broken. ---larre Answer Strategy | Search Terms ---------------------------------------------------------------------- "picking stocks" dartboard study WSJ dartboard contest "random walk" "wall street" William Sharpe dartboard study .