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?
About JT McGee
The correlation between the two is a little surprising. I have invested in local company in the past but do not currently hold any positions.
That is surprising, but I suppose it makes sense. A lot of people subscribe to the whole ‘invest in what you know’ thing, for better or worse.
I doubt it skews the statistics much, but it would be easy for people in certain areas (read: large cities) to invest local without even trying (take me: within 50 miles there are probably 200 companies a majority of Americans have heard of!). 250 miles takes me most of the way to Los Angeles as well, so that’s a huge span of companies that are ostensibly local.
For me, just investing in San Diego companies gives me a huge amount of options. Some have been great – think Qualcomm. But others have been busts…lots of busts…
This does make sense but I do find it surprising. I really avoid investing in individual companies and believe more-so in broad diversification and using historical data on how to shape the portfolio (i.e. more small cap stocks than large, portions of emerging markets and international, etc).
Everybody has their own way of doing things I guess and it’s up to debate as which is really the “best” route. Mostly though, it’s important that people understand their investment strategy and find what fits best for them.
I like the idea of investing local, but also feel like my judgement may be clouded due to a sense of local pride of nostalgia. The results of the study are surprising, for sure, though. I would think more established, national brands would fare much better. Maybe it’s that the larger brands focus more on their dividend payouts? But it sounds like local investing might be a great way to get your feet wet with company research before investing.
Sure.
The more I heard about OneOK, the more I liked it. They have a good people policy, and happy people make money. Several long-term neighbors are with OneOK. Hence the 50 shares in my portfolio. There were other reasons, but that’s as good as any.
A 4.40% divvy doesn’t hurt, either (OKS, not OKE).
Wow I love this — I try to buy local whenever possible, why not invest in local companies? Thanks, JT!
I did buy stock in a local bank during the 2008 financial crisis. I knew it didn’t have the bad mortgage exposure of the big banks but its stock price was being punished as if it had the exposure. I more than doubled my money on that purchase.
Hey there Robert, Jeremy here and first time chiming in on your site. I do work for a publicly traded company and have not given thought to investigating local companies. I do see there being local websites and publications here that others outside of where I live probably don’t know about. If local companies are getting press in these, I can see that as an advantage to being local.
Do you get much information locally from those where you live about publicly traded companies? Do you own stock in many local companies and if so, how have you found the performance of those stocks to be?
Cheers!
Jeremy
For performance, it all depends on the company. Think about it – because it’s local, you hear the news (good or bad) first. For example, a local company for me would be Qualcomm, which has done really well. However, a company that is local and has done poorly is Bridgepoint Education. However, we heard about the layoffs here first, and I saw it in the national news a few days later.
Plus, not all companies are big and make headlines. For example, have you heard of Entropic Communications (ENTR)? They are a local company that it is easy to get news on here, but not anywhere else unless you’re looking for it.
I like the idea of investing locally. I think one of the drawbacks is access to truly local companies…its tough to trade stock in a small local tire shop even if you wanted to.
Very true on privately held companies. I think the point here is more small to mid cap companies that are different than the big S&P 500 stocks.
Speaking of investing “locally”, there’s the first ever “Nashville ETF” launching. The idea seems so silly and outlandish to me that I can’t believe there will be enough trading volume and fees to keep this issue running for long, but who knows, maybe there’s something about companies local to Nashville that it has some merit?