FA Center: Why Fortune magazine’s ‘most admired’ companies likely won’t be among 2022’s best-performing stocks
If popularity is a virtue on Wall Street, then Pfizer stock is headed for a very good year. But I wouldn’t bet on it.
In Fortune magazine’s 2022 ranking of the most admired companies, released in early February, Pfizer
jumped to 4th place from not being ranked at all last year.
If past is prologue, however, Pfizer’s appearance on the list is more likely a curse than a blessing. That’s because stocks whose Fortune ranking declines tend to outperform those whose ranking rises.
I base this on a couple of academic studies. One, entitled “When Is Good News Bad, and Vice Versa?,” appeared in the Journal of Corporate Finance in 2017. It found a negative correlation between rank changes and stock price performance. The study focused on all companies whose year-to-year Fortune “admired” ranking changed at any time between 1992 and 2012. The authors found that an increase in rank is, on average, followed by worse stock price performance than a decrease in rank.
Another study, which appeared in the Journal of Portfolio Management in 2010, focused on Fortune’s lists for the years 1983 through 2007, and reached a similar conclusion: “Increases in admiration were followed, on average, by lower returns.”
These studies suggest that, in contrast to Pfizer, investors might want to consider the stocks of companies that fell the most in the Fortune ranking of most admired companies.
Again, since the magazine doesn’t publish rankings below 50th place, it isn’t possible to know which companies these are. Mastercard
was in the top 50 a year ago (43rd) but this year dropped out altogether. Among those remaining in the top 50 but falling the most in the ranks are Southwest Airlines
which dropped from 14th to 28th, and Visa
which slid to 47th from 36th.
Negative is positive
Contrarians will not be surprised by the negative correlation between rank changes and subsequent performance, since they are predisposed to believe that the consensus is usually wrong. But even they will be surprised by what the researchers found to be one of the causes.
The Journal of Corporate Finance study found that “the CEOs of firms that experience an increase in score are more likely to undertake acquisitions than are the CEOs of firms that experience a fall in score and the acquisitions are more likely to be value reducing.”
The CEOs engage in this value-destroying behavior because they can increase their power, reputation, prestige and compensation by increasing the size of their companies, even when acquiring another company comes at the expense of shareholders. So CEOs operate with powerful incentives to engage in so-called “empire building,” and an increased rank in Fortune’s list evidently enables them to do more of it.
Note that this study’s conclusion is based on an average of numerous companies over many years, and Pfizer may very well resist the temptation that the researchers identify. But there’s little doubt that the temptation will be present. One Wall Street analyst estimated that Pfizer in 2022 would have $175 billion in “M&A firepower.”
The conclusion I draw? You can admire a company without also believing that its stock represents good value. If you’re nevertheless tempted to invest in a company whose ranking has jumped in Fortune’s ranking most admired companies, such as Pfizer, be especially on the lookout for its CEO engaging in acquisitions that make little sense other than to increase his power and prestige.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at email@example.com.
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