Saturday, October 27, 2007

Do Finance Profs practice what they preach?

Sometimes the most important finding of an article is not played up while lesser items (especially those that appear to more exciting or controversial) are given more play. For instance from SmartMoney:

Finance Profs Reveal How They Invest Own Money (The Pro Shop) |
"Colby Wright, assistant professor of finance at Central Michigan University and James Doran, finance professor at Florida State University, [survey] ... finance professors. After all, they're arguably the most educated and well-informed people when it comes to understanding the mysteries behind stock price movements. [I think the article somehow left out 'best looking", funniest, and "nicest" as well.] So Wright and Doran set out to survey all the professors of finance in the U.S. and ask what's most important to them when investing their own money. The survey resulted in 642 usable responses. They published their results earlier this year in a paper titled 'What Really Matters When Buying and Selling Stocks?"
The findings were not exactly what we would think. For instance the survey suggests that PE ratios, market multiples, and momentum investing are among the keys and not CAPM, efficient markets and the market risk factors.
"Out of 43 variables given, the most important were a company's price/earnings ratio and how close a stock is to its 52-week high to low. Considering the material most finance professors teach their students as a way of explaining stock price movements — like the capital asset pricing model and discounted cash flows — Wright calls the findings surprising"
Which is true to a degree, but virtually all finance classes also cover market multiples, such as PE ratios, in some format. For instance in my classes I harp on the fact that both Discounted CAsh Flow analysis and multiples are really doing something very similar just in a different way and there is a place for both. In fact, we generally say that the time to perform a DCF projection is often not worth it for small investments.

Had that been the entire story it MIGHT have been blog worthy. However, after reading the actual article it screamed "Blog me!"

It could be argued that the main finding of the paper was not the reported use of mutliples and momentum investing, but that
"...over two-thirds of the sample are passive investors, and not because they don’t have the time to invest."

Thus, the headline grabbing headlines were not from the entire sample but only a small subsample of active investors.

Which to my biased reading suggests that the majority of finance professors do appear to practice what they preach!

Whew ;)

Interesting article.

Doran, James S. and Wright, Colbrin, "What Really Matters When Buying and Selling Stocks?" (4/13/2007). Available at SSRN:

1 comment:

Shadox said...

After I got my MBA, and set through all those finance classes where profeesors preached about efficient markets and the fact that few (if any) investors can consistently beat the market averages, it would be ALARMING if professors acted against their own advice. Indexing it is.

I am all passive myself.