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

Table 2 reports the monthly excess returns of the top five, 10, and 20 stocks, all 100 stocks, the EGP stocks, and the S&P 500. All of the excess returns from the first and sixth editions of Walden's selections are higher than those of the S&P 500. In fact, the excess return of the top five stocks from the sixth edition exceeds that of the S&P 500 by over two percentage points, 0.846% versus -1.262%, and by nearly two percentage points, 0.681% versus -1.262%, in the case of the top 20 stocks. Combining the results from the fourth, fifth, and sixth editions, we find that the excess returns on the portfolios exceed those of the S&P 500 in 13 of the 15 possible comparisons, or 87%, a compelling percentage for the individual investor. However, we also see that none of the excess returns from the second edition exceeds that of the S&P 500, which tempers this conclusion.

The top five stocks show the strongest performance, exceeding the S&P 500 in every edition except in the second. In contrast, the 100 stocks register the weakest performance, beating the S&P 500 only in the first, fifth, and sixth editions. The excess returns of the top 10, 20, and EGP stocks each exceed those of the S&P 500 in four of the editions. These results support Walden's advice to reduce the number of selections before investing.

The excess returns of the top 5, 10, 20, and EGP stocks are higher than those of the S&P 500 in 17 of the 24 possible pair-wise comparisons, or 71%. When expanding the comparisons to 30 by including the 100 stocks, we find that the portfolios beat the S&P 500 20 times, or 67%. Overall, it is conceivable that some individual investors would find these numbers sufficiently attractive to buy the book.

Table 3 provides the risks of the portfolios based on monthly standard deviations. They range from a low of 2.472% (100 stocks, third edition) to a high of 6.737% (top five stocks, second edition). The fifth edition has the highest standard deviations, with an average of 5.700% across the five portfolios. The third edition has the lowest, with an average of 2.935%. Not surprisingly, by virtue of naïve diversification, the 100 stocks and the S&P 500 generally register the lowest risks on an edition-by-edition basis. In fact, the 100 stocks have the lowest risks in the third through the sixth editions. As expected, the smaller portfolios generally have the highest risks. In fact, by holding portfolios of either the top five or top 10 stocks, the individual investor would incur about 25% more risk than if holding the S&P 500, a noticeable increase.

The risks offer a perspective on the results in Table 2, allowing an assessment of the degree to which higher risks accompany higher returns. For example, in Table 2, the top 10 stocks from the fourth edition show a gain of 2.304%, 16% higher than that of the S&P 500 at 1.984%. Yet, the higher gain comes at the price of a standard deviation that is 32% higher than that of the S&P 500, 4.143% versus 3.145%, suggesting that the higher returns are no bargain. For the same edition, however, the EGP portfolio has an excess return of 2.224% that beats that of the S&P 500 of 1.984%, and does so with a lower standard deviation, 3.105% versus 3.145%. The same conclusion holds for the top 10 stocks from the sixth edition and, as previously mentioned, for the 100 stocks from the fifth and sixth editions. The higher returns coupled with lower risks indicate superior performance. To search for additional evidence of it, we turn to the Sharpe ratios, which are in Table 4.