A Great Company Can Be a Great Investment

Gary Smith, an economics professor at California's Pomona College, thinks as many informed investors do that despite its triumphs now probably isn't the best time to buy shares of Genius Corp. Why? As Smith himself teaches his students, a great company doesn't necessarily make a great stock. By the time a company and its CEO are touted on the cover of a magazine, everyone already knows about them and how wonderful they are. Their virtues are already factored into the share price, leaving it nowhere to go but down. This is known as the efficient market hypothesis.

That's what makes the results of a study co-authored by Smith called "A Great Company Can Be a Great Investment" all the more surprising. The Pomona professor found that contrary to the efficient market hypothesis certain popular companies that have become household names tend to outperform the broad market.

Smith put together portfolios based on Fortune magazine's annual list of the 10 most-admired companies in the U.S. For the study, Smith took the top-10 companies from 1983 to 2004 and compared those returns with the S&P 500 index's returns. He found that the Fortune portfolio, which usually consisted of big-name blue chips like General Electric (GE), Dell (DELL), Berkshire Hathaway (BRK.A), Starbucks (SBUX) and Microsoft (MSFT), outperformed the S&P 500 by an average of six percentage points during the year following the publication of the list.

The results, Smith says, didn't jibe with his typically contrarian investing outlook. "There may be something to buying stock in great companies, which I never believed before," he says.

[via Russ@value_investment_thoughts]