Institutional Trading Confirms Mispricing in Value and Glamour Stocks

Institutional investors exploit expectation errors in value versus glamour stocks by buying value stocks with strong fundamentals and selling glamour stocks with weak fundamentals.

A study examined institutional investors’ buying and selling of mispriced value/glamour stocks based on book-to-market (the inverse of price-to-book value) anomalies, financial strength, institutional ownership and arbitrage availability. To determine book-to-market anomalies and financial strength of value and glamour stocks, quarterly observations were made on institutional ownership of stocks in the U.S. from 1982 to 2015 using the Thomson Reuters Institutional Managers Holdings database.

The researchers noted that institutional investors tended to buy fundamentally strong firms in value stocks and sell fundamentally weak firms in glamour stocks. Joseph Piotroski’s F-Score, comprising nine fundamental factors, was used to measure financial strength: High F-Scores indicate undervaluation (strong fundamentals) and low F-Scores indicate overvaluation (weak fundamentals).

The returns on value/glamour stocks were largest in the stocks with expectation errors—i.e., high F-Score value stocks and low F-Score glamour stocks. Institutional investors were found to trade according to the book-to-market anomaly in undervalued/overvalued stocks. In the stocks that appear more fairly priced, more institutional buying takes place in glamour stocks (with strong fundamentals) and less in value stocks (with weak fundamentals).

Mutual funds and hedge funds were more likely to participate in these types of trades than passive-leaning institutional investors, such as banks and insurance companies.

The study’s conclusions are useful for individual investors who utilize metrics, such as the F-Score, to exploit market mispricing. If investors can take advantage of these market mispricings, they may be able to create a strategic advantage.

Source: “Do Institutional Investors Exploit Expectation Errors in Value/Glamour Stocks?” by Iftekhar Hasan, Jianfu Shen and Chi Cheong Allen Ng; SSRN, December 2022.