Are Good Companies Bad Investments?

Abstract

If investors confuse the quality of a firm with its attractiveness as an investment, shares of well-run companies will be bid up too high and subsequently produce negative abnormal returns. This analysis of Fortune's annual surveys of “America's Most Admired Companies” for 1983-1996 finds the opposite. After adjusting for size, book-to-market, and momentum effects, a portfolio of the most admired decile of firms earns a positive abnormal return of 2.5 percentage points in the year after the survey is published and 7.9 percentage points over three years. The least admired decile of firms earns a negative abnormal return of 7.6 percentage points in the nine months through the end of the year, approximately half of it reversed in the first quarter of the next year. The extent of these abnormal returns, and their persistence over five years, suggests that admired firms are underpriced. The timing of returns to least admired firms provides evidence of window-dressing.