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UI business professors: 'January effect' on small stocks is overstated
IOWA CITY, Iowa -- The idea that stock market investors will see big profits
in January on their small-company stocks -- the so-called "January effect"
-- is overblown, according to a recent study by three University of Iowa business
"Historically, smaller stocks seem to do well in January when you look
at the returns on paper," says Timothy Loughran, assistant professor
of finance. "But a good paper return doesn't necessarily translate into
profits. When you make a few real-world adjustments, the 'January effect'
In their study, Loughran, Joel L. Horowitz, professor of economics, and N.
Eugene Savin, professor of economics, analyzed monthly returns for companies
traded on the New York Stock Exchange, the American Stock Exchange and the
Nasdaq exchange from 1980 to 1996.
Comparing the returns of companies with large capitalization (shares outstanding
multiplied by the price of shares) and the returns of companies with small
capitalization, the study found little overall correlation between company
size and returns.
The study, entitled "Asset Pricing: Does Firm Size Really Matter?,"
found that companies with the smallest capitalization averaged a higher return
in January (8.4 percent) than those with the largest capitalization (2.3 percent),
but found that for the rest of the year large companies easily outperformed
small companies (large companies' average return was 1.25 percent compared
to 0.69 percent average return for small companies).
But the study points out that, on closer analysis, much of the growth for
small companies in January evaporates because the reported returns don't consider
the transaction costs involved in trading.
When the Dec. 31 price is raised by $0.125, the returns for small companies
in January drop to a negative 0.18 percent while returns for large companies
go from 2.34 percent to 1.94 percent, according to the study.
In addition, the reported growth is based on the difference between the price
bid for the stock on Dec. 31 and the price asked for the stock on Jan. 31
of the next year. Few traders would be able to actually command those prices,
the study says.
"On paper, it looks as if there's a lot there for small capitalization
stocks in January," Loughran says. "But the smaller you go, the
more transaction costs will eat into your profits."
Loughran says selling by investors to balance their tax burden also may play
a role in seemingly higher returns for small capitalization stocks in January.