In search of information content: portfolio performance of The 100 Best Stocks to Own in America

Financial Services Review, Summer 2005 by Anderson, Randy I, Loviscek, Anthony L

Ho: portfolios of Walden's stock selections do not consistently outperform a broad market index on a risk-adjusted basis.

We test this by tracking the out-of-sample, risk-adjusted returns of 30 portfolios constructed from the stocks listed in each of the first six editions of the book: 1989, 1991, 1993, 1996, 1998, and 2000. In turn, we compare them to those of a broad market index.

Given that Walden's selections represent a subset of large-cap stocks of well-established companies (e.g., Coca Cola, Gillette, Home Depot, Medtronic, Microsoft, Merck, Philip Morris, and Wrigley), we choose the S&P 500 as the market index. Of the 30 portfolios, 24 contain stocks that are equally weighted and six have stocks that are weighted according to Markowitz's mean-variance criteria.

This study follows the spirit of those by dayman (1987) and Kolodny, Laurence, and Ghosh (1989). They examine a popular book by Peters and Waterman (1982), In Search of Excellence: Lessons from America's Best-run Corporations, dayman and Kolodny et al. examine whether the stocks of these best-run corporations, on average, realized superior risk-adjusted returns. The authors conclude that they did not. Researchers, however, have yet to address whether the same conclusion holds for Walden's stock selections.

We follow Walden's time frames to track the performance of each set of portfolios. Using the Sharpe ratio, we compare the risk-adjusted returns of each portfolio to the risk-adjusted returns of the S&P 500 from one edition to the next. We use monthly rates of return, as taken from the University of Chicago's Center for Research in security Prices (CRSP), to build the portfolios and track their respective performances.

Walden reportedly screens approximately 2,000 stocks across the NYSE, AMEX, and NASDAQ exchanges. He examines a company's performance history by using six variables, four of which are financial: earnings per share growth, stock price growth, dividend growth, and dividend yield. He awards points, one through four for each category, depending on the strength of the earnings (e.g., four points for a 10-year earnings per share growth of at least 500%), the stock price (e.g., four points for a 10-year growth rate of at least 600%), the dividend (e.g., four points for a five-year growth rate of at least 160%), and the size of the dividend (e.g., four points for a two-year yield average of at least 4%). To these variables, he adds two qualitative variables, what he calls "consistency" (e.g., companies with strong and steady earnings per share growth), which carries a maximum of four points, and "shareholder perks" (e.g., dividend reinvestment plan), which also carries a maximum of four points. Walden ranks the stocks by these points. The top-ranked stock has the most points; the bottom-ranked stock has the least.

The rest of the paper is organized into four sections. section 2 explains the portfolio construction methods. section 3 describes the tracking of the portfolios. section 4 presents the results and discusses the implications. section 5 concludes the study.