Enrich Your Future 07: The Value of Security Analysis

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 07: The Value of Security Analysis.LEARNING: Smart investors, like smart businesspeople, care about results, not efforts. “Smart investors, like smart businesspeople, care about results, not efforts. That is why “smart money” invests in “passively managed,” structured portfolios that invest systematically in a transparent and replicable manner.”Larry Swedroe In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over the 30 years to help investors as the head of financial and economic research at Buckingham Wealth Partners. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 07: The Value of Security Analysis.Chapter 07: The Value of Security AnalysisIn this chapter, Larry explains how to test the efficiency of the market by looking at how good security analysts are at predicting the future. If they can outsmart the markets, then the markets are not efficient.Do investors who follow security analysts's recommendations outperform the market?In business, results are what matters— not effort. The same is true in investing because we cannot spend efforts, only results. The basic premise of active management is that, through their efforts, security analysts can identify and recommend undervalued stocks and avoid overvalued ones. As a result, investors who follow their recommendations will outperform the market. Is this premise myth or reality?To answer this question, Larry relies on the robust findings of academic research in the paper Analysts and Anomalies. The authors meticulously examined the recommendations of U.S. security analysts over the period 1994 through 2017. Their findings debunk the myth of analysts' infallibility and shed light on the surprising ways analysts' predictions conflict with well-documented anomalies. They also found that buy recommendations did not predict returns, though sell recommendations did predict lower returns. Another intriguing finding was that among the group of "market" anomalies (such as momentum and idiosyncratic risk), which are based only on stock returns, price, and volume data, analysts produce more favorable recommendations and forecast higher returns among the stocks that are stronger buys according to market anomalies. This is perhaps surprising, as analysts are supposed to be experts in firms' fundamentals. Yet, they performed best with anomalies not based on accounting data.The evidence in this academic paper suggests that analysts even contribute to mispricing, as their recommendations are systematically biased by favoring overvalued stocks according to anomaly-based composite mispricing scores. The authors concluded: "Analysts today are still overlooking a good deal of valuable, anomaly-related...