If you plan to profit from investing in stocks, take a close look at this graph.
The graph highlights two significant phenomena that the Capital Asset Pricing Model (CAPM) fails to explain. First, high Book-to-Market stocks (Value Stocks) yield higher returns compared to low Book-to-Market stocks (Growth Stocks), and small companies yield higher returns compared to large companies.
These two parameters are so important that Morningstar features a dedicated barometer on its homepage: Morningstar.
These two points are crucial because CAPM critics have found little else to counter it in over 50 years, and also because the statistics are quite counter-intuitive.
For example, large companies are generally expected to have a greater competitive advantage, at least due to economies of scale, but statistics show this is not the case.
Moreover, currently, leading positions are held by industries where the balance sheet value of capital doesn’t play a significant role in their market value—particularly tech companies. However, if you follow the hype surrounding such companies, your wallet will be, on average, 4.4% thinner.
Interesting statistics can be found here: Dimensional.
Photo and insights source: From the book.
Principles of Corporate Finance,
By Richard Brealey, Stewart Myers and Franklin Allen