Investors looking for higher returns may want to focus on a company's location instead of its growth potential, according to a new study led by researchers at Penn State. They found that portfolios built to consider company headquarter location and the housing market together could produce returns three times higher than portfolios focused on growth stocks alone.
The analysis, published in the Journal of Empirical Finance, incorporated real estate data to solve a longstanding finance puzzle of why value stocks - typically representing mature, stable companies in sectors such as manufacturing and healthcare - appear to consistently outperform more exciting, growing businesses such as technology companies. The researchers found that companies in more expensive areas like Silicon Valley and New York have higher labor and infrastructure costs, meaning more money is spent running the business instead of returned to investors. The researchers said the findings suggest that not only could investors consider regional housing trends when building their portfolios, but firms could factor in how location influences stock performance.
"Where firms locate their headquarters matters," said co-corresponding author Timothy T. Simin, professor of finance at Penn State's Smeal College of Business. "We found that there's a real practical implication for investors - where companies are located plays a role in their portfolio return."
The researchers assessed 9,308 companies across three stock market exchanges in the United States from 2000 to 2019, the last year for which complete data was available. They sorted the companies' stocks based on their book-to-market equity values - a measure of a firm's assets minus liabilities, divided by the firm's share price multiplied by how many shares they have outstanding. If this ratio reveals that the assets are worth more than the share price, the company is considered a "value stock." If the stock market prices are higher than the assets, the firm is labeled a "growth stock."
"There's a puzzle known as the 'value-growth premium,' which refers to how value stocks consistently outperform growth stocks," said co-corresponding author Brent W. Ambrose, professor of real estate and director of the Borrelli Institute for Real Estate Studies at Penn State's Smeal College of Business. "In the scientific literature, it appears that value stocks overperform in the market and growth firms are underperforming. We're proposing a new model explanation that people haven't really thought about before."
There is no finance or real estate model that can explain the value-growth premium phenomenon, according to Ambrose. So, the team brought both finance and real estate models together, along with urban economics - an approach that combines geography with economic theory. After sorting firms as value or growth stocks, the researchers categorized them based on whether their headquarters location was in a less or more expensive region of the country according to the house price index, which tracks how residential housing prices change over time.
"In regions with more expensive housing markets, growth firms have the worst return," Simin said, explaining that this is likely because companies put more money into their own physical infrastructure and into their labor force, since they live in higher cost-of-living areas. "That doesn't mean companies shouldn't have their headquarters in those locations - there are a lot of benefits, such as proximity to other high-tech firms among others - but companies should factor this understanding in so that they know it means there will be less return available for their investors."
Ambrose noted that the findings could also serve as a prescription for local governments interested in attracting firms or growing firms already in their area.
"Housing is an expense that firms have to account for: It shows up in their labor costs," Ambrose said. "If a community is trying to encourage more firms to locate in their community, they can work to make sure housing is affordable."
In addition to Ambrose and Simin, Yifan Chen served as co-corresponding author. Chen earned a doctorate in real estate and finance from Penn State in 2022 and is now an assistant professor of finance and real estate at Shidler College of Business at the University of Hawaii at Manoa.
The researchers also expressed gratitude for the alumni support for the Borrelli Institute for Real Estate Studies at Penn State, which helped the team procure the data used in this study.
