Sunday, June 30, 2013

FAJ article on Liquidity Premiums

An interesting article on liquidity as a legitimate factor in addition to size, value, market exposure, and momentum.

A shocking finding:  Firms that moved from the lowest liquidity quartile to the highest liquidity quartile AVERAGED annual returns of 109%!  This is essentially the type of stock I generally look for - stocks with very low trading volumes and approaching paradigm shifts.  Obviously, there are many reasonable trading styles, but it is ironic to me, especially given this finding, that the conventional sentiment on that type of stock is that the low trading volumes are a reason not to buy them.  It is true that most low liquidity stocks stay low liquidity stocks, and that all of the outperformance comes from the stocks that subsequently become more liquid.  This is where idiosyncratic risk becomes especially profitable, if the investor can use fundamental analysis (or momentum indicators, etc.) to somewhat reliably separate the wheat from the chaff, which is, admittedly, easier said than done.

No comments:

Post a Comment