The "Media-ification" of Academic Studies and (Poor) Logic Leaps
The "Media-ification" of Academic Studies and (Poor) Logic Leaps
Academic study has often been misused as a justification for individual investments. The logic doesn't make sense.
Media outlets love human interest pieces, especially around things like health. You know the ones I’m talking about, the ones that “prove” a glass of red wine a day is good for cardiovascular health or some other food that is good for lowering cholesterol. They get to to read a salacious promo like “Coming up next, a surprising new study about your health,” do some terse reporting on the study, and then have some corny banter afterward.
Often, the results of these studies are far overstated. They fail to mention the study's parameters or explain the potential correlating factors that can produce those results. This is pervasive in health and nutrition studies because you can rarely isolate all of the necessary parameters.
I bring this up because the same thing happens in financial media. Academic research papers on investing and stock performance are often cited to explain one’s investing philosophy or mindset. They explain why growth stocks outperform value stocks, or why value stocks outperform growth stocks, or why dividends are irrelevant, or why dividends have provided the bulk of returns for the market over time.
There are so many papers out there providing seemingly contradictory findings that investors get to pick and choose the ones that make the most sense for their argument.
Unfortunately, the presented results in these studies rarely apply to the point someone is trying to make. For investors, this can lead to many making poor investment decisions based on these flawed interpretations.
I get it; critiquing academic papers sounds like the newsletter equivalent of a root canal. I realize this topic probably isn’t too high on everyone’s reading list, but I promise there is an important takeaway here. I will also narrow the focus down to three categories that commonly get cited as to why a group of stocks outperform:
Growth outpaces value: This 2002 study showing that growth outperforms value over the long term is commonly cited.
Value outpaces growth: Numerous papers from Eugene Fama and Kenneth French, founders of Dimensional Advisors, on value outpacing growth. Here’s one example.
Dividend payers outpace the market/have contributed to the bulk of the returns of the market: Numerous wealth management firms have published similar findings.
I’m sure these studies are well-meaning, but there are several reasons why you, the individual investor, might not find the results of those studies as helpful as others might suggest.
What you measure matters: There is no real way to prove that one form of investing is better mathematically or conceptually. Therefore, all of these studies have to rely on historical performance. As we have all experienced in one form or another, deciding to invest has a profound impact on your returns.
In the case of the growth stock study, returns were based on a model portfolio that started making investments in the mid-80s and held through 2001. Now, a dyed-in-the-wool growth investor might say “See! Growth held up through the dot-com bubble”. However, the companies in this model portfolio were the growth stocks of the mid-80s, not the dot com companies of the late 90s. Also, the precise time it measured performance was the best run for growth stocks since the 1920s and 1930s.
Conversely, most of Fama and French's papers measure the period from 1975 to 1995. The mid-70s to early 80s was also one of the shining moments in value investing history.
Let’s not forget about those dividend studies! This Hartford Group study explains how dividends have accounted for most of the market’s returns. It just so happens that the first 40 years of this study (1940s to 1970s) were the ideal time to incubate a dividend reinvesting portfolio (low price appreciation, high dividend payouts). If we were to recalibrate this study starting in 1980, the results would be radically different.
(Also, of course, a portfolio where every dollar is reinvested for 80+ years performs spectacularly. I’m sure my portfolio would look like a work of art if I made my first withdrawal 25 years after I’m dead).
In all three cases, they just happened to capture a period where the investing style they purported was ideally suited the time they measured.
Selection matters: The challenge with building these extensive studies is finding broad-stroke filters to bucket the data into something measurable. In the case of both the growth and value papers, they used “high PE” and “low PE” as filters to determine what classifies as growth or value. This involved sorting a large collection of companies, ranking them by PE ratios, and assigning the top or bottom percentages of the group as value or growth, respectively.
If you step back and think about it, this is a gross oversimplification of growth and value investing. Value isn’t just finding cheaply priced stocks; it’s finding businesses where the fundamentals are better than what the market thinks at the time. Growth is finding companies with a chance to expand revenue and earnings over several years at high rates. While high and low PE ratios are common traits, we can all likely think of companies with high PEs we wouldn’t call growth and low PE stocks that aren’t mispriced.
Similarly, the stocks selected for these papers were based on a selection of companies selected early in the study. So, what may have been a growth company in 1984 may not qualify as a growth company in 1999. Unfortunately, an academic paper titled “This specific cohort of stocks that were considered growth stocks from 1983 to 1987 outperformed their value counterparts over 18 years” doesn’t quite have the same ring to it.
Studies assess an index or basket and may not reflect individual companies. This is the primary way people misinterpret dividend studies. These dividend studies often track the performance of a dividend index rather than a portfolio of companies that remain consistent throughout the study. Any individual company within an index can get hot-swapped in and out with other companies if they don’t meet the criteria.
Yes, the index of companies with a 25-year history of increasing dividend payments and a title that makes them eligible for the House of Lords (I didn’t use the term S&P Global; you can’t sue me!) has done extremely well over time, but the chances of any single company within the group outperforming is worse than a coin flip.
And most importantly…
None of these studies judge the businesses behind these stocks: Buy-and-hold investing works for value and growth stocks. It works because we perform due diligence on the business behind the ticker and then let the company's earnings power do the heavy lifting for us.
These studies don’t filter out the wheat from the chaff. If you want to buy stocks based solely on the price action of the ticker. Then these studies are for you. If you give a hooey about the business behind your investment, you might as well throw these studies in the trash.
I just blabbered for 1,000 words to get the takeaway: None of these papers matter to individual investors buying and holding individual stocks. Financial writers who use them aren’t using them to help you make better decisions; they are just a hook to make some (poor) justification of some stock they want to sell you (or to get you to subscribe to their newsletter. Not this newsletter, though, I’d never stoop to such shameless tactics).
(Fine, some shameless tactics).
Tuning out the noise is a critical skill for any investor. From a practical standpoint, these academic studies are just as much noise as any other CNBC “Markets in Mayhem” chyron. Focusing on the business matters most, regardless of what any study tells you.