A study by Roger Ibbotson and Thomas Idzorek, “Dimensions of Popularity”, published in the Journal of Portfolio Management, Vol. 40, No. 5, 2014 shows that the most popular stocks as measured by trading volume underperformed the least popular stocks by 7% over the following year.
The stocks were divided into quartiles (top 25%, second 25%, etc.) over the period from 1972 to 2013 and the authors looked at price changes in each group over the next year. They found a correlation between the popularity of stocks (as measured by share turnover) and their return one year later. The less popular stocks performed better, suggesting that when investors jump on bandwagons, they often push stock prices higher, with less potential for further appreciation.
The authors theorize that less popular stocks may be perceived by investors as being less liquid, more risky or less likely to grow, causing mispricing and opportunities for buyers willing to not follow the herd.
Does it make sense for you to go out and buy unpopular stocks? Perhaps, if you are willing to do some homework to evaluate the fundamental characteristics of the stock you are buying. Stocks are often out of favor for a good reason, so it makes sense to do careful research before making any investment. If you do not enjoy or do not have the skills to do this type of research, a good alternative is a mutual fund whose manager has a high ActiveShare rating (see my blog entry September 13, 2013).