Big asset growth = big trouble

Big asset growth = big trouble

Firms with large asset growth tend to underperform the market




asset growthThe stock market has a way of crushing the hopes and dreams of investors who buy growth stocks. Problem is, they usually pay far too much for stocks that have grown a great deal only to see them slow down.

While much has been said about earnings growth, academics recently turned their attention to asset growth and the news isn’t good. They figure firms with large asset growth tend to underperform the market.

Professor Kenneth French examined the phenomena. In one study, he split the U.S. stock market into a five by five matrix of 25 portfolios based on size (market capitalization) and 1-year total asset growth (in percentage terms).

He first sorted stocks into five groups by size and then split each group into five portfolios by asset growth. Each of the resulting 25 portfolios was held for a year and then the whole process repeated. In this way he was able to track the performance of each slice of the market from July 1963 to March 2015. The results are shown in the table below.

Annual Performance of U.S. Stocks by Size and Total Asset Growth (%)
Total Asset Growth (%)
Lowest Low Middle High Highest
Size Largest 14.0% 12.2% 12.0% 10.7% 7.3%
Large 13.5% 13.5% 13.3% 13.0% 8.8%
Middle 15.8% 16.1% 14.2% 14.1% 7.5%
Small 13.7% 15.4% 15.7% 15.2% 6.8%
Smallest 19.8% 18.3% 16.7% 14.9% 6.8%
Data Source: Professor Kenneth French, July 1963 to March 2015

As you can see, stocks with the highest asset growth rates underperformed those with lower growth rates. By way of comparison, the market gained 10.0% per year on average over the period and it beat the top asset growers handily.

To get an idea of how much asset growth was too much it is useful to know that stocks in the highest categories had growth rates well north of 30%. (Such out-sized growth was probably the result of corporate actions like mergers.) On the other hand, stocks in the next to highest category had asset growth near 15%, the middle group had rates near 8%. The low growth firms had low single-digit rates of about 2% to 3% while stocks in the lowest category usually saw their assets shrink modestly on a year-over-year basis.

Overall, the lesson seems clear. You should shy away from stocks with high 1-year total asset growth while favouring slower growers. In addition, smaller stocks tend to fare better than larger stocks.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of May 11. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase–barring some calamity.

Name Price P/B P/E Earnings Yield Dividend Yield
BCE (BCE) $53.60 4.10 19.01 5.26% 4.85%
Potash Corp (POT) $39.15 2.88 18.30 5.46% 4.67%
CIBC (CM) $95.10 2.07 13.10 7.63% 4.46%
Rogers (RCI.B) $43.48 4.11 17.32 5.77% 4.42%
Shaw (SJR.B) $27.18 2.69 16.28 6.14% 4.36%
Bank of Nova Scotia (BNS) $65.61 1.69 11.47 8.72% 4.15%
Bank of Montreal (BMO) $78.08 1.47 12.33 8.11% 4.10%
National Bank (NA) $49.05 1.86 11.22 8.91% 4.08%
TELUS (T) $42.38 3.34 17.73 5.64% 3.96%
Royal Bank (RY) $79.17 2.23 12.59 7.94% 3.89%
Source: Bloomberg, May 11, 2015


Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

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