CXO Advisory Group has uncovered a superb paper Stocks of Admired Companies and Spurned Ones by Deniz Anginer and Meir Statman, which finds that the most admired companies on Fortune Magazine’s annual survey of list of “America’s Most Admired Companies” had lower returns, on average, than stocks of spurned companies from April 1983 through December 2007. Further, Anginer and Statman find that increases in admiration were followed, on average, by lower returns.
Anginer and Statman describe their methodology as follows:
Fortune has been publishing the results of annual surveys of company reputations since 1983 and the survey published in March 2007 included 587 companies in 62 industries. Fortune asked more than 3,000 senior executives, directors and securities analysts to rate the ten largest companies in their own industries on eight attributes of reputation, using a scale of zero (poor) to ten (excellent): quality of management; quality of products or services; innovativeness; long-term investment value; financial soundness; ability to attract, develop, and keep talented people; responsibility to the community and the environment; and wise use of corporate assets. The rating of a company is the mean rating on the eight attributes. The list of admired companies in the 2007 survey includes Walt Disney, UPS and Google, with ratings of 8.44, 8.37 and 8.07. The list of spurned companies includes Jet Blue, Bridgestone and Stanley Works, with ratings of 5.25, 5.34 and 5.37.
The mean rating of companies in some industries, such as the 6.53 of the Communications industry, are higher on average than those of other industries, such as the 5.26 of the Agricultural Production industry. Our focus is on companies and we distinguish company effects from industry effect by using industry adjusted ratings of companies. They are the difference between the rating of a company and the mean rating of companies in its industry.
Consider two portfolios constructed by Fortune ratings; each consisting of one half of the Fortune stocks. The admired portfolio contains the stocks with the highest Fortune ratings and the spurned portfolio contains the stocks with the lowest. We construct the portfolios on April 1st of 1983, based on the Fortune survey published earlier that year1. We calculate the returns of the portfolios during the 12 months from April 1st 1983 to March 31st 1984 from daily returns. We reconstruct each portfolio on April 1st of subsequent years based on the Fortune survey published earlier that year and calculate returns similarly during the following 12 months.
CXO summarize the findings as follows:
- Over the entire sample period, the mean annualized equally-weighted (value-weighted) return for the unadmired (lower half) portfolio is 18.3% (16.1%), compared to 16.3% (13.8%) for the admired (upper half) portfolio.
- Risk-adjusted alphas of an annually reformed hedge portfolio that is long (short) the unadmired (admired) stocks is sometimes positive and sometimes insignificant, depending on whether the risk adjustment is beta only or multi-factor.
- Increases in admiration generally indicate lower future returns. For example, the mean annualized equally-weighted return of the stocks in the most unadmired quartile for which reputation decreased (increased) relative to the median is 18.8% (13.2%).
- The dispersion of returns is higher within the unadmired portfolio than the admired one. Among the 12 stocks with the worst (best) annual returns, 11 (9) come from the unadmired portfolio. Investors seeking to exploit “unadmiredness” should therefore diversify widely among unadmired stocks.
- The effect is non-linear. The annualized return of an equally-weighted portfolio of the 10 least (most) admired stocks is 13.4% (16.6%). The next ten most and least admired stocks have about the same annualized return. However, for rankings 21-30, 31-40 and 41-50, unadmired stocks substantially beat admired stocks.
In summary, the stocks of companies unadmired by the ostensibly well-informed may well outperform the stocks of the companies admired.
Why might this be so? I’d like to venture a guess. Anginer and Statman’s findings would seem to accord with the findings of Josef Lakonishok, Andrei Shleifer, and Robert Vishny in Contrarian Investment, Extrapolation and Risk (and the The Brandes Institute update Value vs Glamour: A Global Phenomenon. Those two papers found that value stocks (defined as the lowest decile of stocks by price-to-book) outperformed glamour stocks (and by a wide margin).Recall that glamour stocks are those that “have performed well in the past,” and “are expected by the market to perform well in the future.” Value stocks are those that “have performed poorly in the past and are expected to continue to perform poorly.” LSV say value beats glamour because investors don’t fully appreciate the phenomenon of mean reversion, which leads them to extrapolate past performance too far into the future. It’s possible that “admired” can be a proxy for “glamourous” and therefore Anginer and Statman have identified another aspect of this phenomenon. Admired companies are bid up like glamour stocks, and scorned companies are ignored like value stocks, which creates the opportunity for contrarian bet. I love a counter-intuitive strategy.