Friday, January 28, 2005


Even more about Cramer’s investment performance!

Okay, perhaps I jumped the gun by giving Cramer credit for handily beating the S&P 500 over the past 3 years. The facts are not in question: Cramer’s Realmoney portfolio did beat the S&P by about 6 percent annually since the beginning of January 2002.

What’s at issue is the interpretation of this result. Let me explain. Cramer invests in relatively large stocks that comprise the S&P 500. Thus, it seems reasonable that one should compare his results to the S&P 500. Yes, but not quite. You see, when investors pick stocks from the S&P 500, they don’t typically weight their portfolios by the capitalization of each stock. So if I wanted to buy Intel and Tupperware because I thought they were both great companies, there’s no reason why I would buy 100 times more TUP than INTC simply because INTC has a market capitalization 100 times that of TUP.

Thus, when benchmarking performance, one should use an index that gives equal weight to the stocks in the S&P 500 (the equal weight index), as opposed to the standard S&P 500 index that one always sees that weights the stocks based on their market capitalization. Now, as it turns out, over long periods of time, the market capitalization S&P 500 index tends to yield about the same return as the equal weighted S&P 500 (well, almost as large since midcaps have historically outperformed large caps by a small margin). However, as this chart shows (after opening, click the 'compare to' button), the past 5 years have been exceptional, with the equal weight index outpacing the market cap index by an incredible 55 percent on a cumulative basis. Since the beginning of 2002 (when Cramer's portfolio was formed), the equal weighted S&P 500 index has outperformed the market cap weighted S&P 500 index cumulatively by about 22 percent. Moreover, the equal weighted S&P 500 index has even outperformed the Russell 2000 over that time.

And by how much has Cramer outperformed the market cap weighted S&P 500 in that time? Oh, by about 22 percent. In other words, Cramer’s portfolio has done no better than the equal weight S&P 500 index. Now, I am not going to disparage the for advertising the fact that Cramer has beaten the market cap weighted S&P 500. That’s the benchmark that everyone uses, including myself. Furthermore, no matter whether one likes or dislikes him, it's hard to deny that he is a smart guy with lots of brilliant insight into how the stock market works. However, the fact remains that Cramer’s portfolio has done about as well over the past 3 years as the average return on 1 million portfolios constructed by taking the stock picks of 1 million monkeys throwing darts at a list of stocks in the S&P 500. Come to think of it, there is a certain simian quality about the guy...

Interesting post about the S&P equally weighted. Made me realize how many non-tech stocks have gone on to all-time new highs and how the bear market wasn't as bad as most people make it seem.
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