October 15, 1998

Inside Business Week's "Inside Wall Street"
by Louis Corrigan (TMF Seymor)

Nearly every Friday, the Fool Lunchtime News reports on some stock that has moved after being featured in Business Week's "Inside Wall Street" column. The column's power to send a stock higher or lower presumably follows from veteran reporter Gene Marcial's ability to survey his vast array of contacts among Wall Street's pros and get the inside dope on a hot story before it's widely known. Marcial typically focuses on rumored takeover targets, stocks selling at a discount to their putative breakup value, or promising small caps ready to take the market by storm.

The "Inside Wall Street" column is not alone, of course, in highlighting what the so-called "smart money" knows or thinks it knows. Most of the leading financial publications feature some similar vehicle. The Wall Street Journal has its daily "Heard on the Street" article. Barron's has Alan Abelson's column. TheStreet.com has Herb Greenberg's daily column. And former USA Today columnist and CNBC correspondent Dan Dorfman once offered his own famously bombastic version of the same before being sidelined by a stroke.

Still, Marcial's column stands out for being so influential, yet so wrong so often. Indeed, the "Inside Wall Street" column testifies to how little individual investors should listen to the "pros" or "money-runners" that so often serve as the anonymous sources for Marcial's work. Most of the imminent takeovers he talks about never happen. Many of the hot small caps he highlights prove excellent short candidates. (And some of the shorts would be terrific longs.)

Overall, an investor would do better simply putting money in an S&P 500 index fund than by following the advice given in "Inside Wall Street." That's right, this column devoted to spying out the hottest stories by talking to what are supposedly the smartest professionals ends up delivering what Fools have come to expect from "money pros": a lame performance.

In the July 6, 1998, issue, Business Week finally provided what it had never offered before -- an accounting of how the "Inside Wall Street" (IWS) picks have fared. The magazine took all the 172 stocks mentioned during 1997 and tracked their gains for one day, one month, three months, and six months. Results for each stock were compared with the performance of the S&P 500, the Russell 3000, and the Dow Jones Industrial Average (DJIA) over the exact same period. The results were then averaged to produce the following performance chart.

 
 Index    1 Day   1 Month  3 Months  6 Months 
 S&P       0.1%      1.9%      7.0%     15.4% 
 Russell   0.05%     1.7%      6.7%     14.8% 
 DJIA      0.03%     1.3%      5.2%     11.6% 
 IWS       4.7%      5.4%      7.8%     15.1% 
 

This welcome move to become more accountable came with some serious spin. While Marcial noted that "the column produced some sparkling winners -- as well as some crushing losers," his summary conclusion was that "[t]he column has performed pretty well indeed." Some investors would disagree.

For starters, Foolish investors gauge an investment approach against the performance of the S&P 500 index because it's quite easy to just buy an index fund and be guaranteed pretty much market-performing results. Mutual funds are relatively unattractive because they can't guarantee this and, in fact, seldom deliver results that match the S&P, much less beat it. Business Week's own data show that the "Inside Wall Street" theoretical portfolio fails to meet this threshold.

What's worse, the data presented is misleading. Profiled stocks jumped 4.7% on average on the Friday they appear in the magazine. In practice, they regularly "gap up" on the open and commonly do not touch Thursday night's closing price (or go below it) during that first day. In other words, an investor attempting to buy a featured stock on a given Friday would have to pay a couple of percentage points more than he would have paid Thursday night. Thus the 4.7% average first day return is enjoyed only by folks who owned the stock before the column featured it.

That means the 15.1% six-month return is a fiction. A real money portfolio trading along with the column would have been lucky to muster a 12% to 13% return on the 1997 stocks. The theoretical portfolio's results over the shorter periods are similarly phantom. Tracking the results as the magazine does makes a certain sense, but it's also the only way they can be made to look good versus the three comparison indexes. Indeed, Marcial notes that 40% of the stocks featured last year had negative returns after the first month following mention in his column. That's an impressive accomplishment in a bull market!

The posted numbers also ignore the significant trading costs associated with buying and (one assumes) selling 172 stocks. Also, these profits would fall into the short-term gains camp, so that the tax hit would be significant. By comparison, an S&P index fund minimizes such trading costs and delivers mostly tax-advantaged long-term gains.

Next -- "Inside Wall Street" Part 2