Unknown Companies Produce Best Stock Returns

INSEAD professors - Lily Hua Fang & Joel Peress, have recently published research which concludes that investors can out-perform the market by investing in stocks with very little media coverage, and few or no analysts following the companies.

The Professors researched all of the listed stocks on the NYSE between 1993 & 2002, and analysed coverage in 4 publications featuring information about each of these companies. The publications were: the New York Times, USA Today, Wall Street Journal, and Washington Post.

The Professors found that companies with no media coverage during the period of the study, performed (risk adjusted) on an average 3% p.a. better than stocks with better media coverage. In the small cap segment, this out-performance was even more prominent, with "no-media" small cap stocks outperforming by 8-12% (after factoring in the added risks of investing in small and mid cap stocks).

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What is the source of this out performance?

Value investors would be quite familiar with this concept. By definition, value investors are in the business of seeking out stocks which are being ignored by the rest of the market for various reasons, and to try and hold these stocks patiently until the market re-evaluates the stock . Small, unknown companies are the best candidates for such investments.

The lower the media coverage, the greater the potential for the company to be undervalued in comparison to its fundamentals. For instance, company 'A' might be sitting on a land-bank which, if monetised, may lead to high upside for the stock. However, due to the obscurity of the company, the outside world might not yet discovered this story. If a smart media outlet or analyst picks up the information and highlights it to the rest of the world, then increasing numbers of investors will 'discover' the story and may decide to buy pushing up the stock price.

The best gains will go to those investors who managed to enter the investment before its discovery by the wider world. Hence, it is very important for value investors to constantly be on the lookout for unknown, unsung companies which are below the radar of the media, and the analyst community.