WALL STREET Corporate trades, short sales appear to aid in stock picks
Research provides some growth indicators to watch for when picking stocks.
NEW YORK (AP/Dow Jones) -- Anyone looking for an edge in stock picking might consider keeping an eye on short sales and corporate trades.
These two groups of institutional investors -- short sellers and corporations -- can provide small investors with some indication of where individual stocks might be headed, according to recent research from the Charles Schwab Corp.
The same cannot be said for other groups of "smart-money" investors, like mutual-fund managers or brokerage analysts, said Greg Forsythe, senior vice president of equity model development at San Francisco's Charles Schwab.
In a review of 3,200 of the largest companies by market capitalization, the 5 percent of companies with the lowest short-seller interest in their shares outperformed their peers by 4.4 percent a year going back to 1986, according to Forsythe's research. Meanwhile, the 5 percent of companies with the largest short interest in their shares underperformed by 6.1 percent.
Corporate buyback programs
Similar results were found when it came to corporate buyback programs. Using the same test group, Forsythe found that the 5 percent of companies with the greatest reduction in shares through corporate buyback programs outperformed by 4.9 percent a year. The 5 percent of companies that issued the most shares since 1986 performed below their peers by 8.3 percent.
"People will kill to outperform the market by a percent or two," but it means knowing what information to cull, Forsythe said.
People who think they can just follow the pros will be disappointed to learn that not all institutional investors can provide a solid signal of future returns, he said.
Brokerage stock ratings, for example, are more likely to provide a contrarian view when it comes to stock prices. In a review of brokerage ratings going back to 1992, Forsythe found that the 5 percent of companies that received the highest ratings by brokerage firms performed below their peers by 2.7 percent a year. The 5 percent that were least recommended beat their peers by 12.9 percent annually.
Other studies of smart-money indicators have provided similar results.
A 2002 survey by brokerage ratings provider Weiss Ratings Inc. discovered that 47 out of 50 brokerage firms covering companies that went bankrupt that year continued to recommend that investors buy or hold shares even as they filed for Chapter 11 bankruptcy protection.
Meanwhile, a study by two Prudential Financial Inc. principals, published by the Financial Analysts Journal in May, determined that corporate insider sales that also accounted for large percentages of an insiders' holdings predicted "significantly negative future abnormal returns."
Despite evidence to suggest the validity of certain smart-money investors over others, debate remains over the usefulness of following them for small investors.
The problem with following the big money makers is that news of their trades is often reflected in the price of the stock so swiftly that small investors often don't have a chance to benefit, said Mitchell Conover, assistant professor of finance at the University of Richmond in Virginia.