A theory is something that is not proven true, but backed by continuous testing and supporting evidence. In finance, no theory is tested more than the theory of efficient markets – that is, all known information is always priced into a particular security.
Researchers have an incredible interest in the idea of informational asymmetry, the idea that one person or group of people can have more or better information than everyone else. So far, researchers have proven something very interesting: investing in local stocks seems to boost returns. In fact, the highest returns for individual and institutional investors seem to come from local stock holdings.
A 1997 study revealed that investments in local firms (those within 250 miles) outperformed the market. The most concentrated positions – the local holdings in the highest quintile – beat the market by 6.6% per year after adjusting for risk.
Why Investing Locally Might be a Good Idea
There are a few reasons why you might want to consider investing in firms closest to you:
- A Unique Connection – Often, what we see in the financials may be very different than what we see when we look at the business’s competitive environment. If I were to look just at the financials, I could really get into a company like Noble Roman’s pizza. However, having grown up smack dab in the middle of Noble Roman’s country, I know the product is…well, awful.
- Informational Advantages – You likely know quite a few people who work for publicly-traded companies. By talking up your friends and acquaintances, you can get a very good view of the future of a business. Are your friends happy working for XYZ company? Was Jim’s new BMW funded by a performance bonus, indicating that his employer might be knocking the socks off Wall Street’s estimates?
- Inside Information – Public companies in small cities make headlines in local papers, but they don’t get the same coverage elsewhere. In this day and age, most newspapers have an online edition that can be read for free, but it doesn’t mean that investors are finding this information and pricing it into a company. What’s newsworthy in your local area might not be perceived to be newsworthy to a whole organization. Those who are local may very well know better because they’re taking in the small stuff, the information often overlooked.
- Easier Research – It’s pretty easy to drop in on a small retailer to check in on sales when you live within driving distance. Likewise, you can get a much better understanding of a company by surveying local suppliers and customers than you can reading about the business from thousands of miles away. I’m sure investors who invest in local companies are much more likely to take their due diligence to a new level when it’s merely a matter of getting in the car for real, hands-on research.
- More Tolerance for Disappointment – If you know a company well from living near it, you’re more likely to tolerate the ups and downs. Familiarity bias is very real – we know gas is expensive because we see the price every day. Likewise, we know a business might be priced too high or too low because we can observe with our own eyes how the company operates.
When I first saw this study I was astounded. I expected there to be some bias towards holding local companies, but I never imagined that buying local might just boost returns by as much as 6.6% per year.
Do you invest in any local companies? Do you have a preference for local companies vs. distant investments?