When Good is Bad

The mission of most investors is to find the best companies to put their money into. Analysts and amateurs alike scrutinize financial statements, earnings releases, annual reports, 3rd party research, conference call transcripts…anything they can get their grubby little hands on to help discern the quality of a company.

Once done, these stalwart investors place their orders and sit back, confident they've chosen quality companies and great investments. But while they kick their heels up, the truly savvy investor is just getting started with the analysis.

It's true that finding good companies is vital to investment success over the long haul. Strong management, efficient operations, and especially significant advantages relative to competitors all spell success.

But finding the best companies is only a part of the equation in achieving investment success. A good company and a good stock are two different things. Case in point: a recent study published by Deniz Anginer, Ken Fisher, and Meir Statman shows that even the perceived best companies can under-perform the market.

Stocks of Admired Companies and Despised Ones
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=962168

The paper asks the question: "Do stocks of admired companies yield admirable returns?"

The authors found that Fortune magazine's annual list of "America's Most Admired Companies" had lower returns, on average, than stocks of "despised" companies during the 23 years from April 1983 through March 2006.

"We link differences between the returns of stocks of admired and despised companies to differences in affect, the quick feeling that distinguishes good from bad, admired from despised. The affect of admired companies is positive, and investors who were attracted by affect to stocks of admired companies paid for it with lower returns."

It's highly unlikely that the Fortune survey gets things consistently backward—the most "admired" companies in the survey year to year are probably very well run operations. So, what does it mean? First, it's an example of the efficiency of public equity markets—if everyone believes a certain company is a good investment then by definition can't be because that information is priced into its stock already.

But more than that, the study proves the simple notion that the "best" companies don't always outperform. Often, in fact, the "good" companies give you bad returns. In the end, it's just another reminder that to be a successful investor it's not enough to simply come up with a cogent analysis of a company. Others—perhaps many others—have likely come to the same conclusions with the same publicly available information. One must find meaningful information the market hasn't already priced in. So it's not just finding a good company, it's finding a way to see a good company that the rest of the market is interpreting incorrectly. Until then, the best that can be hoped for is market-like returns or below.

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