People tend to pay more for brand name consumer products than generics–and stocks are no different, says Yale professor Roger Ibbotson. This according to an article in CFA Institute.
“Popular stuff has higher valuations but lower expected returns,” he said during a talk at the CFA Institute Annual Conference, citing the example of how Bayer aspirin attracts a significant consumer base even though it is more expensive than the generic version (that delivers the same content).
His thesis, termed the Popularity Asset Pricing Model (PAPM), builds on the well-known Capital Asset Pricing Model (CAPM) which correlates return with risk. It is also the subject of a book Ibbotson co-authored, Popularity: A Bridge between Classical and Behavioral Finance, that defines popularity using three characteristics (quantified using data from Interbrand, Morningstar and Nielsen): brand value, competitive advantage, and company reputation.
To demonstrate the power of popularity, Ibbotson’s talk included a comparison of the popularity of growth and value stocks. He explained that behavioral finance tells us that “investors gravitate toward growth stocks that have stories attached to their success, because human beings respond positively to stories. We are less inclined to prefer value stocks, which inherently tend to have something wrong with them. The flows of such stocks act as a deterrent, which is why they are discounted.” But when value stocks start to generate returns, Ibbotson explained, they become popular. Then, when returns diminish, they lose that popularity and the cycle begins again.
The article concludes: “Investing is hard. Assets are usually unpopular for a reason and finding the ones that will turn around requires both skill and luck.”