Here's A Potential Way To Beat The Market
If you want a shot at beating the market, you're better off with stocks that aren't widely followed. And if you do your homework, you might uncover a gem that has been overlooked or is unmistakably underpriced. Indeed, it's possible to quantify this phenomenon. Companies that are neglected by Wall Street do better over time than widely followed companies.
In the 1980s, a study was published that documented what has come to be known as the neglected firm effect. The use of the term "neglected" meant that the stock had few analysts tracking it and/or few institutions owning it. Thus, on the basis of how many analysts provide earnings estimates, the average number of analysts following stocks of similar size is 24.
This study which takes both analyst coverage and institutional ownership into account also shows that up to half of the S&P 500 stocks are neglected by analysts.
A brokerage hires analysts for two main reasons: to make investors want to buy securities from the firm and to make companies want to issue their securities through the firm. And that's why most analysts are never bearish!
With a lot of analysts following a stock, then, there's a lot of pushing to buy the stock, and it may be less of a bargain than its wallflower peers.
Like any other investment criterion, neglect is not enough to make a buy by itself. You have to do your homework... So much for underfollowed stocks.
What about stocks that have virtually no coverage at all? These tend to be the smallest companies. Here, the neglected stock effect gets muddled by another phenomenon, which is whether small companies in general happen to be in favor on Wall Street. Thus the time to be in small stocks is whenever you feel that they are in position to assert their traditionally superior performance.
Thus, there are two ways to exploit the neglected stock effect: by buying big, underfollowed stocks or by buying small, unfollowed stocks.
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In the 1980s, a study was published that documented what has come to be known as the neglected firm effect. The use of the term "neglected" meant that the stock had few analysts tracking it and/or few institutions owning it. Thus, on the basis of how many analysts provide earnings estimates, the average number of analysts following stocks of similar size is 24.
This study which takes both analyst coverage and institutional ownership into account also shows that up to half of the S&P 500 stocks are neglected by analysts.
A brokerage hires analysts for two main reasons: to make investors want to buy securities from the firm and to make companies want to issue their securities through the firm. And that's why most analysts are never bearish!
With a lot of analysts following a stock, then, there's a lot of pushing to buy the stock, and it may be less of a bargain than its wallflower peers.
Like any other investment criterion, neglect is not enough to make a buy by itself. You have to do your homework... So much for underfollowed stocks.
What about stocks that have virtually no coverage at all? These tend to be the smallest companies. Here, the neglected stock effect gets muddled by another phenomenon, which is whether small companies in general happen to be in favor on Wall Street. Thus the time to be in small stocks is whenever you feel that they are in position to assert their traditionally superior performance.
Thus, there are two ways to exploit the neglected stock effect: by buying big, underfollowed stocks or by buying small, unfollowed stocks.
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posted by Bob Moser at
4:03 PM
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