<THE EVENING NEWS>
Wednesday, June 10, 1998
DJIA 8971.70 -78.22 (-0.86%) S&P 500 1112.28 -6.13 (-0.55%) Nasdaq 1773.26 -27.50 (-1.53%) Value Line ndx 945.46 -10.52 (-1.10%) 30-Year Bond 106 +1 8/32 5.70% Yield
Online bookstore Amazon.com (Nasdaq: AMZN) climbed for a fifth straight day today, charging up another $2 7/8 to $54 1/8 after gaining $5 yesterday. The company, which has links on many Internet content aggregator/search engine sites, benefited from a nasty-looking short squeeze after yesterday's announcement of General Electric's (NYSE: GE) investment in CNET Inc. (Nasdaq: CNWK) and in the content provider's Snap! portal and search service. Also contributing to Amazon's run this week was its announcement Monday that the number of members in its Associates program, which refers visitors to Amazon from other websites, has doubled in the past four months to more than 60,000 members.
Internet software and search engine company Inktomi Corp. (Nasdaq: INKT) -- pronounced "INK-to-me" -- shot up $18 to $36, doubling from its initial offering price of $18. The San Manteo, Calif.-based company recently signed an agreement with Yahoo! Inc. (Nasdaq: YHOO) to provide the search engine for Yahoo!'s Web directory and navigational guide. CNET's (Nasdaq: CNWK) Snap! Web directory also has agreed to use Inktomi's search engine, and America Online (NYSE: AOL) has licensed Inktomi's traffic server software. In addition, the company provides worldwide search services for Microsoft's (Nasdaq: MSFT) online properties. Inktomi is also expanding its business to Europe and Asia -- it opened a European branch in March and just signed a deal to distribute its traffic server software in Japan.
QUICK TAKES: Wal-Mart (NYSE: WMT) gained $1 3/16 to $59 1/4 after The Wall Street Journal reported that the retailer is building its first supermarket called "Wal-Mart Food & Drug Express"... Walt Disney Co. (NYSE: DIS) rose $1 13/16 to $118 5/16 after announcing that its shareholders have approved the entertainment company's previously announced 3-for-1 stock split, for which the company has set June 19 as the record date... Bristol-Myers Squibb (NYSE: BMY) moved up $1 9/16 to $113 3/4 after a study showed that its hypertension drug captopril reduces the risk of diabetes in patients with high blood pressure. Merck (NYSE: MRK), which also makes a hypertension drug, gained $3 1/8 to $126 1/8... Gap Inc. (NYSE: GPS) leapt $2 1/16 to $62 1/2 after BT Alex. Brown reiterated its "buy" rating on the casual apparel retailer.
Some banks bounced up after Federal Reserve Chairman Alan Greenspan testified before the Joint Economic Committee of Congress today and said that inflation pressures remain in check, suggesting that there would be no interest rate hike any time soon. BankAmerica (NYSE: BAC) moved up $1 to $86 5/8; Banc One Corp. (NYSE: ONE) added $1 1/16 to $57 9/16; and First Chicago NBD (NYSE: FCN) gained $1 7/16 to $91... Netscape Communications (Nasdaq: NSCP) edged up $15/16 to $25 1/8 after President and CEO Jim Barksdale fulfilled a pledge to raise his stake in the Internet software company... Ameritrade Holding Corp. (Nasdaq: AMTD) gained $1 13/16 to $28 9/16 after the online trading firm announced that its customer base has more than doubled in six months to 217,000 accounts from 98,000. CEO Joe Ricketts said he expects "tremendous growth ahead of us."
Nursing home operator Manor Care (NYSE: MNR) jumped $4 9/16 to $35 9/16 after announcing that it has agreed to be acquired by Health Care & Retirement (NYSE: HCR) for about $3.5 billion in stock, including assumed debt. The new combined company will be called HCR Manor Care... Diving and marine construction services company Ceanic Corp. (Nasdaq: DIVE) soared $2 3/8 to $17 13/16 after announcing it has agreed to be acquired by subsea contractor Stolt Comex Seaway S.A. (Nasdaq: SCSWF) for around $222 million, or $20 per share, in cash -- a 29.5% premium over yesterday's close... Healthcare company Integrated Health Services (NYSE: IHS) picked up $1 5/16 to $37 15/16 after announcing plans to sell 11 "non-strategic" nursing homes for $60 million.
Scientific and technical publisher Plenum Publishing (Nasdaq: PLEN) gained $3 5/8 to $72 5/8 after agreeing to be acquired by the Netherlands' biggest publisher, Wolters Kluwer NV, for $258 million, or $73.50 a share... Interconnect products manufacturer Parlex Corp. (Nasdaq: PRLX) jumped $2 1/8 to $15 3/8 after announcing it expects a record level of shipments this quarter and projects results will be "in line" with company expectations... Battery manufacturer Electric Fuel Corp. (Nasdaq: EFCX) surged $13/16 to $5 after its consumer battery division yesterday announced a new zinc-air disposable battery that will offer enough power for a typical user to run an analog cellular phone for up to a week or a digital cellular phone for up to a month... Online database services company FactSet Research Systems (NYSE: FDS) advanced $1 5/8 to $32 1/2 after reporting Q3 EPS of $0.30, up from $0.22 for the year-ago period and topping analysts' estimates of $0.28.
Computer disk drive maker Western Digital Corp. (NYSE: WDC) was spun for a $4 5/16 loss to $11 3/16 after saying late yesterday that it expects a fiscal Q4 loss of more than $100 million due to pricing pressures and lower unit volumes for its desktop hard drives. The results will be "substantially short" of the Street's expectations, the company said. Further, the loss will result in a technical default of the firm's bank line of credit at the end of the quarter, though the company will likely end the quarter with over $400 million in cash on the balance sheet and at least $350 million in common shareholders' equity. The size of the quarterly loss triggered the technical default rather than the current liquidity of the balance sheet. Chairman and CEO Chuck Haggerty said the industry is being hampered by "too many drives in the distribution channel," which has already prompted Western Digital to reduce production. The firm plans to shorten the work-weeks at two of its Asian plants over the next two months. Other disk drive makers fell today as well. Quantum Corp. (Nasdaq: QNTM) lost $2 1/2 to $21 1/4 and Seagate Technology (NYSE: SEG) slid $3/4 to $22 1/4.
Office products supplier U.S. Office Products (Nasdaq: OFISD) slid $2 9/32 to $28 27/32 after the markets gave a lukewarm response to the spin-offs of its School Specialty (Nasdaq: SCHS) school supplies unit and its Navigant International (Nasdaq: FLYR) division. The proposed IPO of Workflow Management (Nasdaq: WORK) was cancelled altogether and the unit was spun-off to U.S. Office Products shareholders instead. An analyst at Cantor Fitzgerald called the transactions "a total disaster," according to Reuters. School Specialty ended the day up $3/8 at $15 7/8 after selling at an IPO price of $15 1/2 per share. Navigant lost $13/16 to $8 3/16 after being priced at $9 per share, and Workflow Management fell $2 to $9 from its initial price of $11 per share. U.S. Office Products also completed a one-for-four reverse stock split, accounting for the ticker change to "OFISD" from "OFIS" until July 9.
Some tobacco stocks lost ground today as a Florida jury ordered Brown & Williamson Tobacco Corp. to pay $500,000 to the survivors of a dead smoker under a smoking liability lawsuit. The decision could hamper efforts by "big tobacco" to reach a national liability settlement with several states and protect themselves from similar suits in the future. Meanwhile, in Washington, President Bill Clinton reportedly is ready to put on his horse trader's cap and swap his approval of an anti-drug bill and tax cuts for married couples in return for the safe passage of a bipartisan tobacco settlement bill in the Senate. Philip Morris (NYSE: MO) fell $1 7/8 to $38 3/8, RJR Nabisco Holdings (NYSE: RN) dropped $7/8 to $26, and Brown & Williamson parent B.A.T. Industries (NYSE: BTI) declined $5/8 to $19 9/16.
Premiere Technologies (Nasdaq: PTEK) tumbled $4 1/16 to $10 3/8 after the provider of 800-based and conference calling services said it expects to report after-tax fiscal Q2 earnings of between $0.09 and $0.13 per share, which is below the Street's forecast of $0.28 per share. The company's estimate does not include about $17 million in charges related to the financial difficulties of a customer and a strategic partner in 800-based services, lower-than-expected revenues from its voice messaging business, and other "unanticipated" costs. Some $7.5 million of the charge will be used to establish bad debt reserves for one 800-based services client who has filed for bankruptcy protection and another that is trying to restructure its liabilities with its creditors. Prudential Securities downgraded the company to "hold" from "buy."
QUICK CUTS: Crude oil prices fell today even though Iran said it will cut production by 100,000 barrels a day following last week's cuts by Mexico, Saudi Arabia, and Venezuela to stem a worldwide oil glut. Oil equipment and drilling services firms fell, as Global Marine (NYSE: GLM) dropped $7/16 to $20 1/8, R&B Falcon Corp. (NYSE: FLC) fell $7/8 to $22 7/8, Diamond Offshore Drilling (NYSE: DO) lost $1 15/16 to $43, and Ensco International (NYSE: ESV) sank $1 3/8 to $20 3/4... Trico Marine Services (Nasdaq: TMAR) capsized $1 1/2 to $15 7/16 after Furman Selz lowered its rating on the provider offshore drilling support services to "hold" from "buy."
Semiconductor maker Texas Instruments (NYSE: TXN) lost $3 3/8 to $52 1/2 after the Wall Street Journal reported that IBM (NYSE: IBM) plans to compete with the company in the market for digital signal processors (DSPs) by offering technical data to its clients in the hopes of garnering orders for custom-made chips. Fellow DSP maker Analog Devices (NYSE: ADI) also fell $1 5/8 to $24 1/4... Cigar maker Consolidated Cigar Holdings (NYSE: CIG) was torched for a $1 3/8 loss to $11 5/16 after doing an about-face and rescinding its prior forecast that fiscal 1998 earnings would top fiscal 1997 results by more than 20%. Instead, the firm warned that earnings in fiscal Q2 will fall below the $0.43 per share earned last year.
Lattice Semiconductor (Nasdaq: LSCC) fell $9 5/8 to $26 7/8 after the maker of ISP programmable logic devices said it expects a 20% sequential decline in revenues and a 30% sequential decline in net income in fiscal Q1. Bear Stearns and Morgan Stanley Dean Witter both cut their ratings on the company... Belden Corp. (NYSE: BWC) tanked $6 9/16 to $32 5/16 after the maker of electrical cable said the Asian financial crisis will reduce fiscal Q2 sales by about $5 million from their levels a year ago. The company expects earnings in the quarter to fall $2.5 million to $3 million short of analysts' estimates. Prudential downgraded the company to "hold" from "buy"... Post-It notes and Scotch tape maker Minnesota Mining and Manufacturing Co. (NYSE: MMM) slipped $4 1/2 to $88 3/8 after being downgraded to "neutral" from "outperform" by Morgan Stanley Dean Witter.
United Technologies (NYSE: UTX), maker of Carrier air conditioners and Otis elevators, slumped $3 11/16 to $87 1/4 after an Air Force general told Aviation Week & Space Technology that the firm's Pratt & Whitney engines may be replaced on the F-15E fighter jet in favor of power plants made by General Electric (NYSE: GE)... Data storage management systems developer MTI Technology Corp. (Nasdaq: MTIC) dropped $1 5/8 to $8 3/4 after warning that its fiscal Q1 EPS will come in below analysts' expectations of $0.18 due to top line weakness in the firm's European operations and delays in shipping its Gladiator 3600 fibre channel product... Ultralife Batteries (Nasdaq: ULBI) fell $2 to $10 after A.G. Edwards downgraded the maker of lithium primary and rechargeable batteries to "maintain" from "accumulate."
Supply chain management software provider Manugistics Group (Nasdaq: MANU) was dumped $3 to $21 11/16 after reporting a fiscal Q1 loss of $0.32 per share compared with earnings of $0.09 per share a year ago. The firm had warned of an operating loss last month... Read-Rite Corp. (Nasdaq: RDRT) slid $3/4 to $7 9/16 after the maker of magnetic recording heads for rigid disk drives said "difficult" industry conditions and declining demand for its products will result in sequentially flat fiscal Q3 sales.
Buy-and-Hold Beats Rapid Trading
Individual investors can beat the market -- but only if they avoid frequent trading. That's the conclusion of an important new study by Brad M. Barber and Terrance Odean, professors at the graduate school of management at the University of California at Davis. Unfortunately, the study also found that the average household turns over 80% of its common stock portfolio each year, in line with the 77% average annual turnover of mutual funds. Such excessive trading helps explain why both individual investors and mutual funds generally underperform the market. The lesson is clear: Investors who think of themselves as actual owners of a business are far more likely to generate enviable long-term returns than are the active traders who try to time the market by rapidly moving in and out of stocks.
Barber and Odean studied the trading activity of 78,000 households that used one large discount broker between February 1991 and December 1996. They found that the average household scored a 17.7% annualized gross return during this period. However, they then factored in reasonable transaction costs, such as average round-trip commissions running at 5% of the principal invested and a spread between the bid and ask prices amounting to 1% of an investment. After such costs, the average net annualized return fell to just 15.3%. By contrast, a value-weighted index of stocks on the New York Stock Exchange, Nasdaq, and the American Exchange (a proxy for "the market") delivered a gross annualized return of 17.1% during this period. For context, the Vanguard fund designed to mimic the performance of the S&P 500 delivered a 16.9% annualized return over this period.
These figures do not account for taxes, which could claim up to a third of the gains for those generating mostly short-term profits in taxable accounts. Since the Vanguard index only trades to mirror McGraw-Hill's changes in the S&P index, its turnover typically amounts to less than 20% a year, minimizing short-term capital gains and thus maximizing long-term return.
Furthermore, the study found that individual investors have a preference for smaller, higher-risk (high beta) stocks as well as a slight bias toward value stocks (low price-to-book ratios). Beta is dubious proxy for risk. Still, if one assumes it's useful, the risk-adjusted net returns of the average investor underperformed the market index by 4 percentage points annually. So for the study period, an investor could have done better with an index fund even while enduring far lower risks to capture that performance.
While 51.8% of investors produced average gross returns that beat the market, only 46% outperformed after expenses. In typical bell curve fashion, 25% of the households turned in net outperformance averaging 7 percentage points a year while 25% turned in net underperformance of 9 percentage points a year. The crucial difference in performance was not so much stock selection as turnover. And transaction costs weren't the only problem. As Odean notes in a related paper, investors sell profitable investments twice as often as unprofitable ones. That is, they tend to hold on to their losers and sell their winners. This proves a faulty strategy because the stocks they sell subsequently do better than the ones they buy.
The penalty for frequent trading is striking. The study breaks down the households into quintiles based on how frequently they turn over their portfolios. The low turnover group averaged just 1.44% turnover per year, meaning they rarely traded out of stocks. The high turnover group sported a 283% average annual turnover rate (115% minimum); investors in this group basically swapped out their entire portfolios three times a year. Gross returns in the highest two turnover groups, as adjusted for their generally higher risk stock selections, underperformed the market by 3 to 4 percentage points annually. The average portfolio in the highest turnover group delivered just a 10% annualized net return while the group with the lowest turnover scored a market-beating 17.5% net return on average. Adjusted for risk, the net return of the high turnover group lagged the market by 10.9 percentage points per year.
Factor in taxes and the frequent trading would look even worse given the preferential treatment of long-term capital gains. This is a major concern because the study found that investors trade more frequently in their taxable accounts (96% annual turnover) than they do in their tax-deferred accounts (72% turnover), exactly the opposite of one might expect if investors were acting rationally to maximize net after-tax returns.
The study is particularly valuable because it examines a huge group of actual investors, folks with typical holdings for people relatively early in their investment lives. For example, the average household in the study owned four stocks worth $41,344, while the median household owned 2.5 stocks worth $14,579. That mix makes sense given the demographics of typical discount brokers during the study period. It also seems likely to reflect a fairly large block of the folks reading this column.
There are some important caveats. First, the transaction costs used in the study to figure net returns have both been reduced substantially in the past 18 months. In January of '97, Nasdaq introduced new trading rules that have helped slice the spread between the bid and the ask prices on Nasdaq stocks, in some cases by a third or more. Also, commission charges for online trading have plunged to as low as $8 a trade from costs of $30 or more just a few years ago. And the most active traders have flocked to online brokers, cutting the cost of frequent trading.
On the other hand, the Barber-Odean study covered a period when small-cap stocks favored by individual investors outperformed large-caps, a phenomenon that no doubt accounted for part of the gross outperformance of individual investors relative the market index. Just the opposite has been true of late, as large-caps have rallied to new highs. Also, the widening of the tax-privileged status for long-term capital gains adds a further reason why a low portfolio turnover should produce superior net after-tax returns today.
A recent Wall Street Journal article drew out two interesting corollaries to this study. First, stock turnover in general has soared in the past few years. In 1997, 69% of NYSE shares changed hands versus just 46% in 1990. In part due to the rise of day-traders who use the Small Order Execution System (SOES), turnover of Nasdaq shares was 199% last year, double the rate seen in 1990. Morningstar also reports that turnover by mutual funds has jumped 16% since 1993.
Second, small-cap growth and value funds, curiously enough, have managed to do better by trading more frequently. That apparent anomaly may suggest that while individual investors may not have an information edge regarding these stocks (though they apparently believe they do), mutual funds actually might. Morningstar's Don Phillips told the Journal that faster trading in and out of these stocks may allow funds to take advantage of good news while avoiding some of the pain when bad news crushes a stock. Of course, there's no escaping the tax effects of such high turnover.
The bottom line is that the Barber-Odean study makes a very strong case for taking a buy-and-hold approach. As the Fool has said repeatedly, people should invest in businesses rather than speculate on stock movements. If you're not mentally prepared to do that, you should really just stick your money in an index fund.
Please see the Motley Fool's Conference Calls page for call information and links to synopses.
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