One of the hottest findings in the recent academic finance literature is known as the “asset growth anomaly” -- firms whose total assets grow from one year to the next year subsequently experience abnormally low returns. Weird, right? 

Let me explain this unusual finding in a nutshell. When young firms grow in size, for sure their stock prices rise. But, should we get excited if a mature gigantic company’s assets increase?  It may even be a bad thing.  For example, why would General Motors need to grow in size?  But yet, we as investors get so excited about growth that we overvalue it sometimes.  When we overvalue something, it is typically only a matter of time the value comes down.

In a paper by Cooper, Gulen, and Schill, published in the Journal of Finance, they describe their main findings succinctly: “As our main test variable, we use a simple and comprehensive measure of firm asset growth, the year-on-year percentage change in total assets. Using the panel of U.S. stock returns over the 1968 to 2003 period, we document a strong negative correlation between a firm’s asset growth and subsequent abnormal returns. Sorting by previous-year firm asset growth, we find that raw value-weighted (VW) portfolio annualized returns for firms in the lowest growth decile are on average 18 percent, while VW returns for firms in the highest growth decile are on average much lower at 5 percent."

I couldn’t believe it. So, I did my own test. I took all U.S. listed-stocks from 1994 to 2007 and for each year, I created deciles based on the size of their total asset growth from the prior year to the current year. Then, I looked at the subsequent annual returns of the stocks in these deciles and calculated their alpha using a straightforward three-factor model. For stocks in the highest asset growth decile, their returns were 151 basis points lower than stocks in the lowest asset growth decile!  And for you statisticians out there, my finding was statistically significant at the 1 percent level.  So, beware of firms whose assets grow, especially for those mature firms where growth cannot be a good thing. 

Kenneth A. Kim is chief financial strategist for Eqis, which provides asset management, practice management and operations automation on an integrated platform for advisors.