CFA Institute

Full of Bull: Do What Wall Street Does, Not What It Says, to Make Money in the Market. 2008by Stephen T. McClellanReview by: Martin S. FridsonFinancial Analysts Journal, Vol. 64, No. 4 (Jul. - Aug., 2008), pp. 94-95Published by: CFA InstituteStable URL: http://www.jstor.org/stable/40390147 .

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Financial Analysts Journal

asset classes. By relying heavily on private equity, real estate, oil and gas, and timberland, his fund has out- performed traditional benchmarks over a long period. Bill Gross of PIMCO and Marvin Damsma of the BP pension fund have implemented the theoretical con- cept of separating alpha (excess return on an asset) and beta (systematic risk). They have created immense value by generating alpha within one asset class and "porting" it to another.

Aside from modern portfolio theory's migration from the classroom to the trading floor, the key devel- opment chronicled in this follow-up book is the rise of behavioral finance. Bernstein quotes Paul Samuel- son's jocular definition of the newer field as "the study of people not doing the rational thing as judged by assistant professors of finance," but he does not view behavioral finance as a threat to established ideas. Rather, he points the way toward a synthesis of theory based on the model of homo economicus and empirical observation of the human brain falling short of that ideal. "Behavioral anomalies," says Bernstein, "are where alpha is born."

The longest chapter in Capital Ideas Evolving deals with Robert Shiller of the Cowles Foundation at Yale. Bernstein classifies him, together with Robert Merton and Andrew Lo, as a thinker who emphasizes the role of institutions in the market. At the same time, Shiller is concerned with the difficulties that individuals con- front in making proper financial choices, such as a tendency toward excessive concentration in real estate through homeownership. Shiller was instrumental in

developing derivatives that enable individuals to insure the value of their homes. Separately, Shiller notes that a 1996 survey found individual investors far more confident in their ability to pick stocks than to time the market, even though his own research indicates that the stock market is much less efficient at the macro than at the micro level.

Imperfections have inevitably crept into the text of Bernstein's book. Paul Samuelson erroneously states, presumably with Ecclesiastes 3:1-8 in mind, that the Bible speaks of a time to remember and a time to forget. Bernstein states that baseball immortal Yogi Berra "is reported to have said that forecasting is very difficult, especially when it comes to the future." It would have been more precise to write, "is spuriously reported. ..." The hoary line has also been put into the mouth of Hollywood mogul Sam Goldwyn.

Such peccadilloes in no way diminish the value of Bernstein's latest tour deforce. Other financial histori- ans can chronicle the evolution of investment thought, but no one can match Bernstein's entrée with its great- est contributors. Myron Scholes, Martin Leibowitz, and Robert Merton are just a few of the masterminds who were glad to give him firsthand accounts of their intellectual journeys. As a by-product of these descrip- tions, readers receive unique glimpses into the lives of the field's greatest innovators (photographs of 17 are included in the volume). In both its sweeping account of investment ideas and the depth of the author's insights, Capital Ideas Evolving is unmatchable.

- M.S.F.

Notes 1 . Hoboken, NJ: John Wiley & Sons. Capital Ideas was reviewed

in the March/April 1992 FA].

Full of Bull: Do What Wall Street Does, Mot What It Says, to Make Money in the Market. 2008. By Stephen T. McClellan. FT Press, (800) 858-7674, www.ftpress.com. 240 pages, $22.99.

Reviewed by Martin S. Fridson, CFA.

The stocks that Wall Street firms highlight as their best picks do not materially outperform run-of-the- mill buy recommendations. Selling a stock on the day of a major recommendation downgrade is unwise. A perfectly smooth earnings progression is not a reason for confidence but for discomfort. A full tax rate is a favorable, not an unfavorable, indicator of a stock's

attractiveness. Stock repurchase plans usually indi- cate that a company's earnings have stagnated. Megamergers never work.

These nuggets of worldly wisdom come from Full of Bull: Do What Wall Street Does, Not What It Says, to Make Money in the Market, a retrospective on author Stephen McClellan's 32 years as a technology com- pany analyst. In lieu of quantitative formulas for stock selection, McClellan offers canny, qualitative criteria drawn from experience. For example, he champions companies that operate in specialized business seg- ments over less focused, generalist companies. He urges investors to beware of managers who have strings of ex-wives and showy sailboats or who sport fancy designer suits and fingernail polish (dismay- ingly, McClellan seems to assume that all senior exec- utives are men). In a surprisingly large number of

Martin S. Fridson, CFA, is CEO of Fridson Investment Advisors, New York City.

94 www.cfapubs.org ©2008, CFA Institute

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Book Reviews

instances, McClellan is able to support his subjective- sounding judgments with empirical evidence. For example, he cites a study that found that the probabil- ity of lackluster stock performance rose with the size and price tag of the CEO's house.

Another main thrust of Full of Bull is a call for upgrading research standards. Fixed-income analysts will be gratified to discover that the author wishes that their level of expertise in financial statement analysis would become the norm for their equity peers. A Chartered Financial Analyst for more than 30 years, McClellan promotes the CFA Program as a remedy for the shortcomings that he perceives within the analytical profession. Many charterholders, how- ever, would oppose his recommendation to make the credential mandatory.

Others might question his disdain for interna- tional investing. After all, focusing exclusively on U.S. stocks eliminates two-thirds of global market capital- ization from consideration. McClellan partly justifies his financial xenophobia on the grounds that a dollar- based investor's gain on a foreign stock could be offset by a loss on the currency. He does not explain why investors should be any less concerned about losses incurred by holding a dollar-only portfolio instead of diversifying among currencies. Investors who are worried about dollar weakness, he says, should buy an exchange-traded fund that represents a basket of international stocks. This risk-spreading strategy con- trasts with his recommendation that individuals own no more than 5 or 10 stocks.

McClellan's endorsement of hyperconcentration reflects a breezy confidence that amateur investors, toward whom he explicitly aims his book, can outper- form the indices over an extended period. Here, his emphasis on empirical verification lapses. The story would be more credible if McClellan could show a precedent for individual investors pulling off a feat achieved by a vanishingly small percentage of professional money managers. He might, for exam- ple, produce a single example of a retail customer of the brokerage houses for which he worked who beat the Wilshire 5000 Index on a risk-adjusted basis over a 25-year span, net of commissions, by buying indi- vidual stocks. As far as the reviewer is aware, no securities firm has ever documented such a case, even though the commercial value of it would be immense.

Many of McClellan's nonprofessional readers, however, will be undeterred by the low probability that their expenditure of time and energy will yield a long-

run premium over a passive strategy. Instead, they will follow the book's advice and conclude that they are really onto something when a few of their picks happen to beat the averages over a six-month span. McClellan fans his readers' hopes by pointing out that they can conduct research without the constraints and conflicts that bedevil Wall Street analysts. Furthermore, they can review earnings models and listen to corporate executives in conference calls. Even McClellan acknowledges, however, that individuals are not on a level playing field with professionals with respect to calling CEOs on the phone or attending institutional investor conferences sponsored by brokerage houses.

In reality, institutional money managers are the more appropriate audience for Full of Bull For them, McClellan provides invaluable insights into the investment merits of low-multiple, non-dividend- paying, small companies.

It is unfortunate, therefore, that his text was not copyedited more carefully. Billionaire Warren Buffett's surname is misspelled throughout the book except in the index, where his company's name, Berkshire Hath- away, is misspelled. The Institutional Investor All- America team, to which McClellan was named for 19 consecutive years, is mislabeled the "All- American team" and elsewhere referred to as the "All-Star" team. Other infelicities include the substitution of "Teutonic" for "tectonic," "incredulous" for "incredible," "exulted" for "exalted," and "affect" for "effect." The book also contains assorted homophonic confusions - e.g., "vane" for "vein," "pour" for "pore"- and the baffling neologism "ensorselled." The text also stum- bles in some instances over verb-subject agreement and the proper use of apostrophes.

Substantively, McClellan erroneously states, "Wall Street research began in 1934 with the seminal text Security Analysis by Graham and Dodd." In real- ity, Benjamin Graham landed his first job as a sell-side analyst almost two decades before he and David Dodd published the renowned textbook.

Notwithstanding these gaffes, Full of Bull is a worthwhile contribution to the securities analysis liter- ature. Countless other books provide stock selection criteria defined in terms of financial ratios, almost invariably with an escape clause to the effect that applying the proposed rules requires judgment. McClellan aids readers immeasurably in acquiring that essential quality.

- M.S.F.

July/August 2008 www.cfapubs.org 95

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