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High Prices Mean Good Stocks?

| | Posted in: Animal Spirits, Equity Premium

Are stocks with high prices or low prices inherently better deals? In their October 2016 paper entitled “Nominal Stock Price Investing”, Ulrich Hammerich, Christian Fieberg and Thorsten Poddig examine the relationship between stock price and future stock performance in the German equity market. Specifically, they each month sort stocks by price and measure the difference in average total returns between the equally weighted tenth (decile) of stocks with the highest prices and the equally weighted decile with the lowest prices. Using monthly prices and total returns for a broad set of German stocks from the end of January 1990 through December 2013, they find that:

  • Stocks with high prices generally outperform those with low prices based on:
    • Gross average monthly return (0.91% versus 0.25%).
    • Volatility measured as standard deviation of monthly returns (3.08% versus 6.28%).
    • Gross monthly Sharpe ratio (0.30 versus 0.04).
    • Four-factor (market, size, book-to-market, momentum) alpha (0.44% versus -0.34%).
  • However, returns of stocks with high prices exhibit negative monthly skewness (-0.86), a relatively heavy left distribution tail, while returns of stocks with low prices exhibit positive skewness (0.44).
  • Stocks with high prices tend to have low-beta with tilts toward small, value and momentum. Stocks with low prices tend to be high-beta with a strong tilt towards small and less strong tilts toward value and away from momentum.
  • Double sorts suggest that the price effect is especially strong among:
    • Medium-sized stocks.
    • Stocks with very low and very one-year high momentum. For example, a high price-high momentum portfolio generates about the same average return as a high momentum portfolio but with lower volatility.

In summary, evidence from German stocks indicates that stocks with high prices outperform stocks with low prices, with both higher average return and lower volatility.

Cautions regarding findings include:

  • Results are gross, not net. Accounting for turnover from monthly portfolio reformation and rebalancing to equal weights would reduce returns. However, turnover for price sorts may not be high.
  • Decile subsamples are small, especially early in the sample period when they consist of only around 30 stocks.

See also “Interactions among Stock Size, Stock Price and the January Effect”.

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