What does a chief executive’s house tell you about future company prospects? What can speeding tickets reveal about the motivations for financial trading? Is there a link between a company’s ticker symbol and its stock performance?
Stock market studies have uncovered all kinds of peculiar and revealing findings. Let’s look at some such examples – and why you should be wary of so-called brothel indicators.
Mansions and CEOs
A study which examined the houses of nearly every S&P 500 chief executive found returns suffer when CEOs buy luxurious houses (929sq m/10,000sq ft or more). The authors created a portfolio whereby they bet against companies where the CEO bought a mansion, and took a long position when modest houses were purchased. Their portfolio outperformed the market by 29 per cent after one year and 46 per cent after three years.
Grandiose purchases indicate the CEO’s “power and prestige” and that he feels “entrenched” in the company, the authors suggest.
Crimes and misdemeanours
Chief executives who have a legal record – even for minor offences such as speeding tickets – are much more likely to commit accounting fraud than "clean" CEOs, a recent study found.
The paper examined every S&P 1500 company involved in fraud over a 15-year period – 109 companies in all. Prior to the fraud, 21 per cent of chief executives had already broken the law, compared to just 5 per cent of bosses at companies where no fraud was committed.
The study also looked at 94 companies forced to restate results but not accused of fraud, and compared them to 70 random companies. None of the CEOs involved in either group had serious legal infractions, although the former group was much worse when it came to minor traffic violations.
The same paper found that CEOs who buy big homes, cars or yachts are much more likely to head firms where fraud occurs.
Off-the-job behaviour is indicative of on-the-job behaviour, the study says.
Lords on boards
The more board members with honorary titles, the worse the company's performance, according to trader and Practical Speculation author Victor Niederhoffer. Niederhoffer examined the 50 largest FTSE companies over a five-year period, and even devised an earnings to lords ratio, where he divided earnings per share by the number of lords on the board.
The reason remains unclear, Niederhoffer asking: “Was it the lords who caused the lacklustre performance or the lacklustre performance that prompted the companies to use lords as window-dressing?”
Skyscrapers and crises
Niederhoffer also notes that skyscrapers can be an indicator of hubris. The Asian financial crisis erupted in 1997, the year the Petronas Towers – then the world's tallest buildings – were completed in Malaysia.
The Nasdaq-christened Marketsite Tower, the world's largest video display, began operating in December 1999, months before the dotcom bubble burst; Enron Tower was almost completed before the company filed for bankruptcy; and the highest building in the world was opened in Dubai in 2010, as the city battled against going bust.
Other examples abound. Barclays has published its Skyscraper Index since 1999, warning of an "unhealthy correlation" between crises and the world's tallest skyscrapers. Skyscraper construction in China and India in recent years is worrisome, the bank cautions.
Ticker symbols
All listed companies have a ticker symbol. Google's is GOOG, Microsoft's MSFT, and so on.
According to Princeton psychologists, companies with the most easily pronounced names outperform shortly after floating on the stock exchange. An investor who invested $1,000 in the 10 companies with the most fluent names would have earned $333 more than an investment in the 10 least fluent names. The outperformance was also evident within six and 12 months of a company's market debut.
“People take mental shortcuts, even when it comes to their investments,” the authors noted.
Speeding tickets and trading
Fast drivers are also fast traders, according to the authors of Sensation Seeking, Overconfidence and Trading Activity. The paper examined speeding tickets issued in Helsinki, where fines are tied to income and are potentially penal, and compared it to a database of investment portfolios. The link was equally obvious in both urban and rural areas, with both speeding and trading activity decreasing as investors aged.
Trading may be a “sensation-seeking” activity such as risky sexual behaviour, drug and alcohol abuse, bungee jumping and gambling, the study suggests.
Psychopathic traders
In a computer simulation, Swiss researchers examined decisions made by 27 traders and compared them to those made by 24 psychopaths in high-security hospitals. The traders wanted to gain more than their competitors and wasted energy trying to damage them, the researchers found, and were more deceitful and Machiavellian than the psychopaths.
A separate study found that people with brain damage which limited their ability to feel fear outperformed others in an investment game. The best risk-takers and investors may have a “functional psychopathy” that allows them to stay cool under pressure, the researchers said.
Round numbers and stocks
We read numbers from left to right, which is why something priced at €9.99 seems more than one cent cheaper than €10. The same effect may be in operation in stock markets.
A paper, Penny Wise, Dollar Foolish: The Left-Digit Effect in Security Trading, analysed more than 100 million Nasdaq orders. At prices ending in 99, buy orders outnumbered sell orders by 66 per cent, making it easily the most popular price point at which to buy. The least popular buy point was numbers ending in 01.
The second most popular price point at which to buy was 49, and the second most popular at which to sell was 51.
Quadrophobia
Studies show companies are more likely to round earnings-per-share (EPS) figures up to the next-highest cent, rather than down – no surprise there, as companies like to meet earnings expectations.
One paper found that companies tend to increase earnings numbers by a tenth of a cent or so. Changing the EPS number from, say, 5.4 cents to 5.5 cent allows companies to round up to six cent.
Examining 489,000 quarterly results over a 27-year period, the authors found the number 4 was the least common first post-decimal point. Numbers 2 and 3 were also underrepresented – every other number was overrepresented.
The “quadrophobia” effect was more obvious when results were close to analysts’ predictions and in companies with high price/earnings ratios. “Persistent quadrophobes” are more likely to restate earnings and to be sued for accounting fraud, the authors added.
Brothel indicator
Quirky indicators should always be tested, as the aforementioned Victor Niederhoffer found out to his cost. Famous for his scientific testing of ideas, his funds returned 35 per cent annually over a 15-year period prior to going bust in 1997.
A friend of Niederhoffer, Bo Keeley, visited Bangkok and reported its brothels were cleaner and safer than before. Niederhoffer viewed this as economic development, and invested several hundred million dollars in leveraged bets on Thailand. The Asian financial crisis followed months later; Niederhoffer went bust.
“I had no scientific basis for investing there,” he admitted years later. “It was purely a qualitative idea . . . I had no knowledge of the country. I’d never even visited the country. All I had done was finance a trip by Bo Keeley to the brothels there.”
Which also shows there is no alternative for investors to doing their homework . . .
