1/10/2008

New York -- As we continue to assess the quality of research, performance metrics (data provided by Investars) are a useful tool for analysis. However, we need to be mindful of both the benefits and drawbacks to performance measurement systems. The performance of buy-sell recommendations is only one facet of what constitutes research quality. Other dimensions of research quality, such as service or analytic quality are more difficult to quantify, but are often more important to investors than recommendations performance.

2007 was a tough year to make money on the long side. It should be no surprise therefore that the composite return of of 4.3% achieved by the universe of Investars tracked firms was mainly driven by the sell recommendations. The composit return was composed of a Buy portfolio loss and a Sell portfolio profit. The overall return was 48% correlated to the sell portfolio batting average and only 3% correlated to the Buy Portfolio returns.

One-Year Perfomance of Buy minus Sell Recommendations
Year ended Decmber 31, 2007
Basis Points per day

Source: Investars

The one year performance data shows B. Riley well out in front of the pack, with a whopping 156 basis point per day return, compared to the next closest rival at a very respectable 30 basis points a day. The results of B. Riley, while impressive, are somewhat affected by the fact that most of the return relates to a single sell recommendation made by the firm. The Sell recommendation provided 164 basis points of the 156 bp return, indicating that the buy recommendations, which number 96 in total, lost on average 7.7 bps per day. So while the return was massive, the probability that this call was luck is heighted by the fact that there was just one sell recommendation, the Buy recommendations lost money and the weighted average batting average of B. Riely was just 28%. This means that the recommended stocks moved in the intended direction just 28% of the time and in the wrong direction 72% of the time.

Given the statistical anomalies that can take place, we include below the top ten research providers over a three year time span, over which luck is much less a factor.

Three Year Performance of Buy minus Sell Recommendations
Three Years Ended December 31, 2007
Basis points per day

Source: Investars

The three year returns provide a more stable picture in terms of performance. The top performer, Zacks, generated a return on its recommendations of just under 10 bps per day. Additionally, all of the top 10 RPs were within 5 bps of each other, clearly a much neater statistical result than the one year returns.

Next week we will assess the two year returns, Batting average adjustments and generate a stock picking ability index for the firms covered by the Investars data.

Note: The performance data has been provided by Investars. The analysis and conclusions are those of Integrity Research Associates