RR #174 - The "Good Company is a Good Investment" Fallacy

It sounds reasonable to say that investing in the most popular companies would produce the best returns, but this is just not how asset pricing works. Today on the show, we unpack the ‘good company is a good investment’ fallacy. Before diving into the main topic, we kick off our discussion on the subject of index funds with Robert Wigglesworth’s Trillions. From there, we share some updates about custom indexing and home buying in Canada, along with the immense valuation of Tesla as well as Elon Musk’s net worth. This acts as a great segue into the focus of today’s show: a so-called good company has high historical returns, strong earnings growth, strong forecasted earnings growth, and high prices. But just because the good companies have done well historically, this does not mean they will continue to be a good investment. In fact, there is a premium that says that higher-priced stocks earn lower returns than lower-priced stocks and value stocks. We unpack several papers that explore the concept that it is the lesser-known companies that tend to have better returns. We also get into how growth extrapolation, the skewness effect, and the big market delusion plays into the good company is a good investment fallacy. Our discussion concludes with the idea that investors are better off paying attention to expected returns rather than falling victim to extrapolation errors. Tune in today!



Books From Today’s Episode:
Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever — https://amzn.to/3DXhUe4
Popularity: A Bridge Between Classical and Behavioural Finance — https://www.cfainstitute.org/en/research/foundation/2018/popularity-bridge-between-classical-and-behavioral-finance

Timestamps:
0:00 Intro
9:30 Cameron’s Recommendations
22:00 The "Good Company is a Good Investment" Fallacy
53:45 Talking cents


Links From Today’s Episode:
Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/
Shop Merch — https://shop.rationalreminder.ca/
Join the Community — https://community.rationalreminder.ca/
Follow us on Twitter — https://twitter.com/RationalRemind
Follow us on Instagram — @rationalreminder
Benjamin on Twitter — https://twitter.com/benjaminwfelix
Cameron on Twitter — https://twitter.com/CameronPassmore
‘The Anatomy of Value and Gross Stock Returns’ — https://www.jstor.org/stable/4480889
‘Stocks of Admired Companies and Spurned Ones’ — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1540757
‘Glamour Brands and Glamour Stocks’ — https://www.sciencedirect.com/science/article/abs/pii/S0167268114000845
‘Investor Sentiment, Stock Characteristics, and Returns’ — https://jpm.pm-research.com/content/37/3/54/tab-pdf-trialist
‘Contrarian Investment, Extrapolation, and Risk’— https://onlinelibrary.wiley.com/doi/full/10.1111/j.1540-6261.1994.tb04772.x
‘Valuation Bias and Limits to Nudges’ — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3225439
‘Conditional Skewness in Asset Pricing Tests’ — https://onlinelibrary.wiley.com/doi/abs/10.1111/0022-1082.00247
‘IPOs as Lotteries: Skewness, Preference, and First Day Returns’ — https://www.researchgate.net/publication/261970609_Initial_Public_Offerings_as_Lotteries_Skewness_Preference_and_First-Day_Returns