Here's proof that underdog stocks can make you more money than the market's 'best in show'

By Mark Hulbert

Shares of companies that fell the most in Fortune's 'Most Admired' ranking outperformed stocks of companies moving up the list

Stocks of companies that fell the most in Fortune's ranking outperformed the stocks of those whose rankings increased the most.

Fortune magazine's list of the "World's Most Admired Companies," released last week, reminds us that the most popular stocks aren't always the best investments.

Consider what has happened to Boeing (BA), which five years ago was in the top 20 of Fortune's "Most Admired" all-star list. Today, as Fortune Chief Executive Alan Murray wryly puts it, the company is "the butt of screw-loose jokes." Boeing shares today trade for less than half of where they stood five years ago.

Not all companies on Fortune's "Most Admired" list suffer such spectacular falls from grace, but Boeing is hardly alone. Several research studies have found that not only do shares of the average "most admired" company fail to beat the market, but they even underperform the average company at the bottom of Fortune's list. Furthermore, shares of companies whose Fortune rankings increase in a given year proceed to underperform those whose rankings fall, on average.

One of the first academic studies of the Fortune list, entitled "Stocks of Admired and Spurned Companies," was conducted by Deniz Anginer of Simon Fraser University and Meir Statman of Santa Clara University. They analyzed the stocks on the magazine's list over a 25-year period, from 1983 through 2007. They found that:

The average least admired company's stock, at the bottom of the Fortune ranking, outperformed the average most admired company's stock by 2.1% on an annualized basis.Stocks of companies that fell the most in Fortune's ranking outperformed the stocks of those whose rankings increased the most. The former beat the latter by 5.6% on an annualized basis, on average.

A subsequent study, entitled "When is good news bad and vice versa? The Fortune rankings of America's most admired companies," was conducted by Yingmei Cheng and Aaron Rosenblum of Florida State University, Baixiao Liu of Peking University HSBC Business School, and John McConnell of Purdue University. They studied the performance of stocks on the Fortune list from 1992 through 2012, also finding that increases in a company's Fortune ranking led to reduced stock performance on average - and vice versa.

Beating expectations is a lot easier for a company that investors despise than for a company that investors think can do no wrong.

Leaders and laggards

Results such as these are why contrarians urge us to cast a skeptical eye toward companies that win popularity contests such as Fortune's. As Rob Arnott, chairman of Research Affiliates, put it to me in an email: "To find a prince, you sometimes have to kiss a toad."

Note that the company you end up "kissing" does not have to be more profitable than princely firms in order for its stock to be the better performer. That's because a stock's future performance is a function of whether it does better or worse than what the market currently expects. Beating expectations is a lot easier for a company that investors despise than for a company that investors think can do no wrong.

For example, Amazon.com (AMZN) is ranked third in this year's Fortune ranking. Arnott and Que Nguyen, chief investment officer of equity strategies at Research Affiliates, contend that Amazon is a widely admired stock that has got "ahead of itself." In an email, they write: "Valuation is stretched. AMZN's quality metrics are terrible (low margins, plows back everything for empire building ... and too much leverage)."

Instead of Amazon, they urge us to consider any of a number "of boring companies that are cheap, profitable and growing." One that they mention in particular is Kohl's (KSS), "which is off-the-charts cheap ... [and] is in or near the best quintile by 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 be audited. He can be reached at mark@hulbertratings.com

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02-10-24 0531ET

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