sealPurdue News

April 2001

Student investors ride January effect
to whopping returns

WEST LAFAYETTE, Ind. – A Purdue University student investment club made real profits of $70,000 – more than 50 percent on its investment portfolio – in the first month of 2001.

It wasn't luck, but it sure wasn't traditional stock-picking analysis, either.

There was, however, a fundamental question, according to Timothy Dona, a finance major at the Krannert School of Management and chairman of the MBA student-managed investment fund: "Our investing experience had made us seriously question whether we could make money picking stocks. After all, look at the big mutual funds with their high-paid managers. They almost never beat index funds."

Mike Cooper

Mike Cooper, an assistant professor of finance, had an idea for the students to try. Using a huge database, the students looked at the January returns of all exchange-listed U.S. stocks since 1970 to identify the criteria for picking a basket of stocks most affected by year-end tax-loss selling.

Investors have heard for years about the January effect, the tendency for the stock market to rise during the first month of the new year. But the January effect, like the Santa Claus rally or the Super Bowl effect, is more anecdotal and qualitative than numerical or analytic.

"We wanted to identify an investment strategy based on tax-loss selling," Cooper said. The students found that buying stocks based on their tax-loss strategy historically brought a 22.5 percent average gain in January. That number is "statistically significant," according to Cooper.

"What the students did was the exact opposite of a Warren Buffett value investment strategy," Cooper said. "We don't care about fundamentals – industry, profits or any of the standard measures. In some cases, we didn't even know what the companies' stock symbols stood for."

The 25 stocks the students finally put in their basket had a small-cap bias, ranging from companies with $10 million to $1.5 billion market capitalization. The mean value of the companies was between $200 million to $400 million capitalization. Twenty-one of the 25 stocks were NASDAQ-listed, high-technology issues.

What the 25 stocks had in common was that historically they had declined significantly in the second half of the year and declined even more in December on high trading volume.

But this was no dart board, Cooper insists. It was, says Dona, very much in the tradition of the Krannert School: a quantitative, analytical, statistical approach.

All this was no academic exercise. The student investment club uses real money.

The $100,000 an alumnus provided in 1998 had grown to $130,000 by December 2000. The club's research team proposed putting the whole amount in what they saw as "small, beaten-down companies poised for a January 2001 rebound."

The research team persuaded club members to make the leap completely out of their large capitalization holdings of multibillion-dollar corporations and put all of the fund's money into the 25 stocks their research had yielded. The stocks rewarded the club richly and quickly. By mid-January, the fund was up to $200,000, a more than 50 percent increase, compared to an 8 percent gain by the NASDAQ and 1 percent for the S&P 500. Only three of the 25 stocks posted negative returns.

Cooper acknowledges that the students' quantitative stock-picking method, called "back testing," isn't new, and that hedge funds and mutual funds employ it in varying degrees. But institutional investors typically don't go back and look at 30 years of history of all U.S. stocks.

An advantage the student investors had over institutional investors was that they were able to invest in small companies that wouldn't be a big enough part of a large mutual fund's holdings to make any appreciable difference in returns.

Some rational observers might object that the students' portfolio was just a lucky sector pick on the old high-risk, high-return model. But Cooper says the database research could have allowed the students to identify stocks in a beaten-down sector ready to bounce back up.

For doubters who persist in the efficacy of fundamental analysis, Cooper points to the realities of stock selection today. "Given the sheer number of stock analysts, a certain percentage is going to make great stock picks," he says. "But the research has shown that the investment world's stock-picking stars have no persistence over time."

Dona and his fellow club members are convinced. They are definitely planning to cash in on next year's January effect. Now their biggest decision on the horizon stems from the club's charter that says the members can choose to spend 25 percent of their investment profits on something for the students.

"We can spend it on new data sources," Dona says. "But there is considerable sentiment for buying a fancy new espresso machine for the student lounge."

Sources: Timothy Dona, (317) 733-9287,

Mike Cooper, (765) 494-4438,

Writer: J. Michael Lillich, (765) 4094-2077,

Purdue News Service: (765) 494-2096;

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