Finance Profs Reveal How They Invest Own Money

Wouldn't it be nice to know what the most important variables are to those who have devoted their careers to studying financial markets? And if Warren Buffett wasn't available, whose brain might you want to pick?

For Colby Wright, assistant professor of finance at Central Michigan University and James Doran, finance professor at Florida State University, it was other finance professors. After all, they're arguably the most educated and well-informed people when it comes to understanding the mysteries behind stock price movements.

So Wright and Doran set out to survey all the professors of finance in the U.S. and ask what's most important to them when investing their own money. The survey resulted in 642 usable responses. They published their results earlier this year in a paper titled "What Really Matters When Buying and Selling Stocks?"

The researchers' objective was not to explain why prices move in one direction or another, but to see whether "the models and theories developed to explain the risk-returns relationship of asset prices mean anything to those investors who actually trade," they write.

"I basically ask them: Out of all the stuff you've read, all the literature, what do you really believe?" says Wright. And whether you agree with why these academics buy or sell a stock, note that the paper says nothing about how successful the professors are with their investments — just what they consider to be the key factors when deciding to buy or sell.

In other words, do these experts practice what they preach?

The answer turns out to be no. Out of 43 variables given, the most important were a company's price/earnings ratio and how close a stock is to its 52-week high to low. Considering the material most finance professors teach their students as a way of explaining stock price movements — like the capital asset pricing model and discounted cash flows — Wright calls the findings surprising.

SmartMoney.com: How are the results of your survey of finance academics important for regular investors?

Colby Wright: The real question we asked is: We've got all this academic literature out there that talks about what should you look at when you buy and sell stocks. What do the real experts look at when they buy and sell stocks? Hopefully, that will be useful to any investor. These professors are the most highly educated, highly sophisticated, they have high statistical training. They're familiar with the research that's been done.... Our ultimate objective was to ask what do finance professors really base their investing decisions on. There's a huge body of research in our field and there's so much conflict in the literature, it's hard to boil it down to what you should and shouldn't use.

We look at what might be helpful to help you beat the market. We emailed all the finance professors in the country...with a list of variables and asked how important are these things to you when you buy and sell stocks. There's been kind of a raging debate in academic circles — is beta the only thing that matters? Then there's a whole camp that says you should look at P/E ratios, investor sentiment and dividend yields. We got some surprising results.

SM: What were the most surprising?

CW: The traditional valuation techniques and traditional asset pricing models — when I say traditional I mean techniques that discount dividends, that use discounted cash flows, CAPM, arbitrage pricing theory, Fama and French, stuff we've taught to undergraduate and graduate classes — that stuff ranks at the bottom of the list. That's basically the laundry list of what we've been teaching people.

We ended up focusing on professors who were trying to beat the market, and who trade stocks at least monthly. So these are not totally ivory tower academics. I call them active traders. When I focused on that group, the things at the top of the list, things they look at most were P/E ratio and market cap — essentially, the size of stocks. After that, it's all related to momentum, which includes the stock's return over the past six months and over the past year, and the stock's 52-week high and 52-week low. So if you're doing a horse race of traditional asset pricing models vs. market anomalies, these guys trade on anomalies.