Impact of Single Stocks on Factor Returns
Do Single Stocks Matter for Factor Investors?
July 2018. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Factor portfolios are typically created by equal weighting stocks
- The impact of single stocks is therefore reduced compared to market-cap weighted indices
- The FAANG stocks impacted factors differently
INTRODUCTION
The famous FAANG quintet of Facebook, Amazon, Apple, Netflix, and Google has driven much of the performance of the Nasdaq 100 in 2018 and currently accounts for approximately 35% of the index.
Such a large contribution from a handful of stocks might seem extreme, but a select few stocks have historically accounted for a disproportionate share of stock market returns. Although it may seem counterintuitive, most stocks underperform their index because of the non-normal distribution of stock returns and the nature of market capitalization indexation, which rewards winners and punishes losers.
Factor portfolios are less affected by single stocks since they are usually constructed equal weight. Nevertheless, the relationship is worth exploring. Using the Value factor as a case study, how do single stocks influence factor returns? And how do the FAANG stocks influence six common equity factors?
IMPACT OF SINGLE STOCKS ON THE VALUE FACTOR IN THE US
We define the Value factor as buying cheap and selling expensive stocks as determined by a combination of price-to-book and price-to-earnings ratios. The portfolio is constructed beta-neutral and selects the top and bottom 10% of stocks with a US market capitalization of over $1 billion This results in a diversified portfolio of approximately 170 stocks each on the long and short sides.
Since the positions are equally weighted, single stocks should have a limited influence. The following chart highlights the 10 stocks that contributed most to positive Value factor performance in the United States from 2000 to 2018. These equities represent a diverse array of industries, with a tilt toward
