Popularity Contest

What makes a stock popular?

Source: Wholeheartedleaders

Do you remember the popular kids in high school? They seemed to have it all: good looks, good athletics, fashionable clothes. But have you ever followed up with your classmates to see how things have turned out? More often you think, folks that seem to have everything going for them don’t. They develop substance-abuse issues, or they can’t hold a job, or they wind up in broken relationships and find it difficult to make commitments. It’s the “Paradox of Plenty” written small—people with abundant opportunities and natural gifts seem to fall short of their potential.

The same thing can happen to stocks. When stocks are popular—as evidenced by high liquidity, broad analyst coverage, and—especially—high valuation, they tend to underperform their less-popular peers. This has been discussed in financial publications. Academics have looked at market anomalies—persistent factors that lead to higher returns—for years. Recently, a couple of researchers examined aspects of equity popularity and found that the least popular stocks tended to have higher returns and lower risk than more popular stocks. This seems backwards. Normally, higher risk is associated with higher returns—like small stocks vs. large caps, or stock vs. bonds. But popularity seems to make stocks more volatile.

Source: Index Fund Advisers

Of course, low popularity is no guarantee of higher returns. Companies tend to get very unpopular just before they go bust. But if your portfolio only has “beautiful people” in it—stocks that everyone wants and is following right now—don’t expect world-beating returns.

Douglas R. Tengdin, CFA

Chief Investment Officer

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