Vijay Singal at Virginia Tech and Jitendra Tayal at Ohio University show that in the US the 10 per cent of stocks with the highest prices outperformed the 10 per cent with the lowest by an average of 4.3 per cent per year between 1962 and 2013. This controls for factors such as size, value, exposure to market risk and momentum. Yes, lowly-priced stocks do well in January. But high-priced ones outperform in the other 11 months.
This trend isn't confined to the US. Researchers at the University of Bremen show that it's also true in Germany. Between 1990 and 2013 the highest-priced 10 per cent of stocks beat the lowest-priced 10 per cent by 0.66 per cent per month, and were only half as volatile.
The UK fits this pattern. The Aim index, which contains many penny stocks, has underperformed the main market since its inception while highly priced tobacco stocks (for example) have done nicely.
There are several reasons for this pattern.
One is simply that stocks get a high price by rising (you don't say) and we know that momentum stocks do well.
Also, high-priced shares are often relatively defensive: think of Reckitt Benckiser, AstraZeneca or BAT. And defensive stocks also do well over time.
A third explanation comes from Justin Birru at Ohio State University and Baolian Wang at HKUST Business School in Hong Kong. Investors, they say, "are suffering from the illusion that low-priced stocks have more upside potential". They show that lower-priced stocks have higher expected skewness and that stock splits, which cut prices, lead to increased expected skewness. Investors, however, pay too much for this small chance of big returns. In this sense, low-priced stocks are overpriced for the same reason that lottery-type stocks are.
There's something else, says Ulrich Hammerich at the University of Bremen. Our common sense, honed by countless everyday transactions outside the stock market, tells us that low prices indicate cheapness and high prices dearness. So we're attracted to low prices in the stock market even though - contrary to common sense - such stocks are not cheap.
Common sense and instinct, though, can be wrong. Sometimes, we need evidence and research instead. We might have had too much of experts in politics, but perhaps we need them in investing.
