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Pomona College research shows beating the
stock market may be easier
than investors think.
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Beating the stock market may be easier than investors think
-- easy as following a popular magazine's most-admired
companies list, according to new research from a Pomona
College economics professor and one of his students.
Professor Gary Smith and Class of 2005 graduate Jeff
Anderson set out to test an enduring piece of Wall Street
conventional wisdom: that great companies often don't make
for great investments. The idea is that if a company already
has an excellent reputation, that knowledge is already built
into its stock price, limiting the potential for big gains.
Known as the "efficient markets hypothesis," this notion has
gained wide acceptance over the years.
Because it is so widely disseminated and publicized, Smith
and Anderson turned to Fortune Magazine's annual list
of "America's Most Admired Companies" to test the
hypothesis, comparing the stock market performance of the
annual top 10 most-admired companies to the performance of the
broader Standard & Poor's 500 index. Their research covered
the period from the list's inception in 1983 to 2004, a span
of 21 years, and is published in the July/August 2006 issue
of Financial Analysts Journal.
The results: the most-admired companies dramatically
outperformed the wider market, yielding annual returns of
17.7 percent vs. 13 percent for the S&P 500.
"It was a big surprise," says Professor Smith of the
results, adding that he "re-checked and re-checked" the data
as a result.
Smith and Anderson's research has the most-admired companies
outperforming the S&P whether the investor purchased the
stocks on the day of the magazine's publication, or 5, 10 or
20 trading days later. Their scenario has investors
purchasing equal proportions of the top-10 stocks, then,
when the next year's list is published, selling them to
invest in the new top 10.
The researchers report that the difference in returns can't
be attributed to the performance of a few standout
companies. Over the 21 years, 214 different company stocks
would have been purchased as part of the Fortune
portfolio.
Professor Smith isn't sure why the efficient markets
hypothesis failed the test, but he suspects the
highly-touted companies benefit more from "scuttlebutt" --
the positive chatter about their performance -- than
numbers-oriented Wall Street analysts realize.
The research started when Anderson delved into the topic, at
Smith's suggestion, for a paper as part of a senior-year
economics seminar. Anderson says the research experience was
"a great way to cap off my four years" at Pomona, a
top-ranked liberal arts college that emphasizes small
classes and undergraduate research opportunities. Today,
Anderson, an economics major from Mercer Island, Wash., is a
portfolio administrator at Mellon Financial in Glendale,
Calif.
Smith is the Fletcher Jones Professor of Economics at Pomona
College and the author of more than 50 articles and several
economics textbooks. He earned his B.A. in mathematics at
Harvey Mudd College and his Ph.D. in economics at Yale
University.
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