Investor Perception vs. Investment Performance

Barron’s, the highly respected financial weekly, last week stated that “Financial planners who manage money for clients are proving to be a fair weather lot.” The article was making the observation that a growing number of money managers (mostly those new to the field) are abandoning their investment disciplines in favor of chasing current investment fads. This trend is occurring because many of them are under fire from their clients for not earning portfolio returns which their clients think they should have earned because of all the media hype about the market.

In this article we want to get past the hype and shed some light on what’s really been happening in the markets by focusing on two recent trends.

The first trend is misleading market indices. Over the past few years the market has favored a particular type of investment � large capitalization growth stocks. Virtually all other segments of the market � small stocks, mid-capitalization stocks, foreign investments, real estate related investments and “value” oriented investments � have all done poorly compared to large growth stocks. If an investor’s portfolio was not concentrated in a relatively few number of large growth stocks, it is a virtual certainty that their portfolios under-performed the popular indexes in recent years.

Some examples (using 1998) will illustrate this:


  • The S&P 500 Index returned 26.7% in 1998, but 42% of the stocks in the index had negative returns; 51% of Nasdaq stocks had negative returns and 53% of all stocks listed on the New York exchange had negative returns.
  • The median stock in the leading index was up just 4.4%
  • 29% of stocks on the New York exchange lost 20% or more
  • 58% of stocks listed on the Nasdaq closed the year more than 20% below their highs
  • Investments in any type of investment linked to real estate declined in value by 22%
  • 87% of the return in the S&P 500 came from just 50 stocks


It’s clear from this information that the popular indexes do not necessarily represent what the general market is doing. Quite the contrary; because of the way these indexes are constructed they can severely misrepresent what the general market is doing. While these variations between the “average” stock and the indexes are nearly unprecedented, not seen since the early ’70s, they are just another temporary trend.

So why is this a problem? Because investor perceptions are influenced by the media. Due to time constraints the media deals in “sound bites,” breathlessly reporting index performance to fill the time between commercials. This can lead some investors to feel that they are “missing the bandwagon.”

The second trend which has been shaping investor’s perceptions in recent months: the Internet stock craze. To illustrate, recently a Fox Channel 5 newscaster reported: “Just to show you how well local stocks have performed, AOL was less than $70 a share a year ago, and now it’s $130.” Is this really representative of how local stocks have performed? Of course not. Note that AOL is trading at 629 times earnings; of the 32 million shares which traded on 3/30, less that 5% came from institutions (so called “smart money”); and AOL’s profit comes from charging its customers two times the going rate for Internet service. While AOL may continue to trade at its current lofty price, we see no compelling reason for buying the stock based on any objective assessment of risk and potential return.

Or, how about Amazon.com (AMZN) selling at a whopping 123 times negative earnings. If you divide the company’s market value by its employees (256) you get $70 million per employee – a highly irrational valuation. This is over 111 times IBM’s ratio of .63 million per employee. Or, consider that AMZN sells $1.2 billion a year worth of books, and total book sales in the US is only $12 billion. Even if AMZN sold every single book published in the US they would still not be profitable, based on their current cost structure. Even if they are successful with their new “auction” strategy to sell everything over the Internet, in our opinion it will still be a long time before they show profits. Rational investors should consider these facts over the hype.

Our priority here at BWFA is to construct and maintain portfolios which accomplish our client’s goals at an acceptable level of market risk. And this mandates holding a diversified portfolio. Our own large cap growth stocks (IBM, SGP, PFE, SUNW, LU, BK, JNJ, etc.) have all done considerably better than the indexes. But we have not concentrated our client’s investments in this sector, because we know that this is neither disciplined nor prudent, no matter what fad happens to be in vogue among greedy day traders or the media.