Jim Cramer Exposed: Does He Generate Alpha?

I turned on the television in my hotel room and flipped the channels. My jaw dropped as I saw a hyperactive Jim Cramer with his sleeves rolled up pressing buttons, conjuring up sound effects, and spouting buy and sell recommendations seemingly on the spur of the moment.

My profession was turned into a carnival sideshow. It was late 2005, and I was watching the television program Mad Money for the first time.

The show, begun in July 2005, has gone on to become the most-watched show on CNBC, with about 380,000 viewers. Web sites are devoted to following Cramer’s recommendations. And, inevitably, there are questions about the quality of Cramer’s advice. Among the reviews have been two highly critical articles on Barron’s that concluded that the stocks he recommended subsequently fared poorly. Those articles, in turn, stirred up Cramer’s devoted followers, who wrote letters arguing that he is an entertainer and an educator—Cramer’s own self-description—and that he offers valuable insights.

Paul Bolster and Emery Trahan, professors of finance at Northeastern University, were curious about all this, and applied the full force of their analytical powers to a study of Cramer’s advice. They published their analysis earlier this year,1 and on August 18, Professor Bolster presented their work, with a preliminary update through 2008, to a small audience of quantitative analysts in Boston.

Their approach addressed five questions:

  1. What was Cramer’s cumulative result versus an appropriate benchmark?
  2. What was the market reaction to Cramer’s recommendations?
  3. Did Cramer generate an alpha? That is, what was Cramer’s risk-adjusted return within the framework of the Capital Asset Pricing Model (CAPM)?
  4. What was Cramer’s risk-adjusted return within the framework of the Fama-French three-factor model, which includes not just the market but also factors for size and value/growth?
  5. What is Cramer’s investment style?

Thanks to one of Cramer’s devoted followers, a Web site compiles all his buy and sell recommendations, which provided the basic data for this study. These amounted to about 1340 buys and 534 sells, from late July 2005 through the end of 2007.2 Bolster and Trahan combined these with returns data from CRSP (the Center for Research into Security Prices).

1 Paul J. Bolster and Emery A. Trahan, “Investing in Mad Money: Price and Style Effects,” Financial Services Review, Vol.18 (2009), pp. 69–86.

2 I write “about,” because there were slightly different numbers for the different kinds of analysis. Cramer’s sells concern only stocks that he has previously recommended; he does not recommend shorting stocks.