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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 professors.

"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' disappears."

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.

12/16/97