“Shares of companies that fell the most in Fortune's rating outperformed shares of companies whose rating rose the most.“
Fortune magazine's list of the “World's Most Admired Companies,” released last week, reminds us that the most popular stocks are not always the best investments.
Consider what happened to Boeing BA,
Who five years ago was in the top 20 of Fortune magazine's “Most Admired” stars list. Today, as Alan Murray, Fortune's CEO, wryly put it, the company is “the butt of silly jokes.” Boeing shares today trade at less than half of what they were five years ago.
Not all companies on Fortune's “Most Admired” list suffer such a stunning fall, but Boeing is not alone. Numerous research studies have found that the “most admired” average company stocks not only fail to beat the market, but even outperform the average company at the bottom of Fortune's list. Moreover, stocks of companies whose Fortune magazine rankings rise in a given year underperform on average those companies whose rankings fall.
One of Fortune's first academic studies entitled Deniz Anginer of Simon Fraser University and Meir Statman of Santa Clara University conducted “Stocks of Admired and Disliked Companies.” They analyzed the stocks included in the magazine's list over a 25-year period, from 1983 to 2007. They found that:
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The average stock of the least admired company, at the bottom of Fortune's ranking, outperformed the average stock of the most admired company by 2.1% on an annual basis.
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Shares of companies that fell the most in Fortune's rating outperformed shares of companies whose rating rose the most. The former outperformed the latter by 5.6% on an average annual basis.
And a subsequent study entitled “When is good news bad and vice versa?” Fortune's “America's Most Admired Companies” rankings were conducted by Yingmei Cheng and Aaron Rosenblum of Florida State University, Baixiao Liu of HSBC Peking University School of Business, and John McConnell of Purdue University. They studied the performance of Fortune-listed stocks from 1992 through 2012, and also found that increases in a company's Fortune rating led to lower stock performance on average — and vice versa.
“Beating expectations is much easier for a company that investors despise than it is for a company that investors believe can do no wrong.“
Leaders and laggards
Findings like these are why contrarians urge us to cast a skeptical eye on companies that win popularity contests like Fortune. As Rob Arnott, president of Research Affiliates, told me in an email: “To find a prince, sometimes you have to kiss a frog.”
Note that the company you end up “kissing” does not have to be more profitable than the princely companies for its stock to perform better. This is because the future performance of a stock depends on whether it performs better or worse than the market currently expects. Beating expectations is much easier for a company that investors despise than it is for a company that investors believe can do no wrong.
For example, Amazon.com AMZN,
It ranks third in Fortune's rankings this year. Amazon is a widely admired stock that has “outdone itself,” assert Arnott and Cu Nguyen, chief investment officer of equity strategies at Research Affiliates. In an email, they write: “Valuation is stretched. AMZN's quality metrics are terrible (profit margins are low, pushing everything back in order to build the empire…leverage is too high).”
Instead of Amazon, they urge us to consider any of the “boring, cheap, profitable, growing companies.” One of the ones they mentioned in particular is Kohl's KSS,
“And it's off the charts cheap… [and] It is in or near the top quintile in terms of profitability, distributions to shareholders, and low leverage.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to audit them. It can be reached at mark@hulbertatings.com
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