EC Why The Riskiest Stocks Have Been Vastly Outperforming Safe Ones

Let’s say you believed that the higher the risk, the higher the reward. Let’s say you loved taking risks. Let’s say you participated in all the Red Bull–sponsored extreme sporting events you could, and you watched those you couldn’t participate in. And you drank their sodas like water, regardless of any health risks.

What kinds of stocks would you buy?

I like to break down factors into seven categories: value, growth, stability, quality, sentiment, momentum, and size. A Red Bull investor would look for the following in a stock:

  1. Value. Extremely underpriced or extremely overpriced stocks. Those are definitely the riskiest.
  2. Growth. Stocks whose growth is high but far from certain. Again, definitely the riskiest.
  3. Stability. The most unstable stocks possible.
  4. Quality. Low-quality stocks. No question there.
  5. Sentiment. Stocks with huge changes in sentiment; stocks which investors can’t make up their minds about; stocks that are either flying under the radar or are heavily shorted.
  6. Momentum. Total mean reversion! Stocks with negative momentum. Beaten-down stocks that are barely hanging on.
  7. Size. Tiny stocks, low-priced stocks.

Well, check out the following charts:

Red Bull Investing charts

The left-hand charts are for these factors between January 1999 and April Fools’, 2020, a few days after the market hit bottom. The right-hand charts are for the most recent four quarters, 4/1/2020 to 4/1/2021. Let’s focus on the right-hand charts for a moment.

  1. Value. As you can see, the most expensive stocks have gone up the most, but besides that, there’s been a steady favoring of cheap stocks as well. The fairly-priced stocks have done the worst.
  2. Growth. These factors have been relatively unaffected. Growth stocks still rule supreme.
  3. Stability. The most unstable stocks have outperformed like mad.
  4. Quality. Low quality is highly favored.
  5. Momentum. Stocks with terrible (or downward) momentum have done by far the best; stocks with high momentum have done OK, but only at the very top end of the chart.
  6. Sentiment. Stocks that are undergoing major changes in sentiment, whether higher or lower, are doing the best.
  7. Size. The tiniest stocks are crushing the others.

Chart Methodology

For those of you interested in how I came up with these charts, here’s my method. If not, feel free to skip this section.

I created these seven factor groups and tested them using Portfolio123. Each of them consists of five factors (see illustration below), equally weighted (except for the size group, which has only three factors). The charts reflect the annualized returns if you were to take all stocks listed on major US exchanges with prices over $1 and divide them into deciles according to how they rank on an equally weighted multi-factor ranking system made up of those five factors, with reconstitution every four weeks. I chose the five factors in each on a discretionary basis—they’re mostly relatively common factors that I use myself. The data I used was FactSet’s.

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Alpha Stockman 3 weeks ago Member's comment

Great contrarian view.