The Relationship Between Brand Equity and Stock Performance

It’s not unusual to see investors gravitate toward the stock of companies they are familiar with. Often these companies have brand equity. Brand equity is the value of a brand name. Among the things a strong brand name does is to allow a company to sell its products at a higher price than its competitors. Examples include exercise equipment company Peloton Interactive Inc. (PTON) and athletic clothier Lululemon Athletica Inc. (LULU).

Some investors like the idea of owning shares in companies they admire or whose products they are fans of. Others view buying shares of such companies as fitting into the Peter Lynch methodology of “investing in what you know.” Still, there is a question as to whether investing based on brand makes sense.

Researchers at Lynn University and Barry University crunched the numbers. They identified companies with brand equity by using data from consulting firm Interbrand. The firm’s annual Best Global Brands report identifies the 100 most valuable brands. Portfolios were then formed with the companies comprising the top and bottom rankings. A second set of portfolios were created based on brand equity growth.

Buying shares of the companies with the best brand equity did not lead to a performance advantage relative to the S&P 500 index. In fact, buying the shares of companies that ranked at the bottom of Interbrand’s list led to higher returns.

Focusing on companies with the strongest growth in brand equity, however, was a winning strategy. The outperformance was largest for a highly concentrated portfolio of the five companies with the strongest brand equity growth. Coming in at number two and number three in terms of performance were portfolios composed of stocks from the 10 and 20 companies with the strongest brand equity growth. Portfolios composed of stocks with companies having the weakest brand equity growth were also the worst performers. In academia, a factor exists if a positive return—in excess of what can be attributed to beta—can be realized by buying stocks with a strong exposure to a trait and shorting stocks with weak exposure to the trait.

Portfolio Returns Based on Ranking Companies by Growth of Brand Equity

Source: “Chasing the Fame: Investing in Brand Equity,” Wei Feng, Robert Reich and Ye Sheng, SSRN.

A caveat to this study’s results is the sample period: 2001 to 2013. Though the study was recently revised, the more recent data was not included. It would have been interesting to see if the results held up during the second half of the last decade.

Still, there is a useful takeaway from the study—how a company uses its intangible assets matters. Simply having a recognizable name is not enough. A company needs to be able to grow the brand’s appeal.

But even if a company’s brand appeal is growing, there is still the question of valuation. When stocks become too popular, they run the risk of not being able to live up to expectations. This, in turn, can lead to large downside moves. An oft-overlooked part of Lynch’s strategy was to buy growth stocks at reasonable prices.