Let’s not take this to extremes, but a recent study offers the counter-intuitive notion that companies with great reputations don’t generally provide great returns for investors – and a decline in corporate reputation can presage better returns.
In the Spring 2010 issue of the Journal of Portfolio Management, economist Deniz Anginer and finance prof Meir Statman look at Fortune magazine’s “Most Admired Companies” rankings from the start of that survey in 1983 up through 2007.
The annual “Most Admired” survey reflects opinions of executives, directors and analysts on companies in their own industries. You might expect the stocks of firms with the best reputations to perform best in the market, but it just isn’t so.
The authors compare portfolios of higher-reputation companies vs. lower-rated firms, looking at 12-month returns following publication of the “admired” ratings:
We find that stocks of spurned companies, or those with relatively low Fortune ratings, beat the stocks of admired companies, or those with relatively high ratings.
… we also find that stocks of companies that moved up the reputation scale lagged stocks of companies that moved down the scale.
This study looks at a relatively short-term trade, a 12-month adjustment after a reputational change takes hold. It doesn’t consider multi-year differences in returns or valuation between respected and disrespected firms.
The authors also don’t explore causes of their counter-intuitive finding. But I believe a key factor is that reputation surveys are lagging indicators:
- A company is recognized for rising reputation after peers in its industry see it deliver strong results, an increasing stock price, high-profile successes. And then? Well, high-flying companies and stocks tend to revert to the mean.
- When bad things happen to a company, peers and analysts are quick to cast blame – the stock drops, company reputation sags. And then recovery begins.
The JPM article confirms what many value investors practice: Out-of-favor stocks may yield more opportunities than “admired” companies riding the wave, for the simple reason that less-popular companies are cheaper than glamour issues. And at least some of the high-multiple stocks are going to hit bumps in the road.
Of course, it isn’t much of an investor relations story to say “Our reputation is in the tank, so things can’t help but get better.” And IR people, as champions of our companies’ reputations, all want rising earnings, strategic accomplishments, recognition in places like Fortune … the good news that creates solid reputations.
But when times are tough, we may find some comfort in the reversion to the mean.