Breadth of Ownership and Stock Returns

We develop a model of stock prices in which there are both differences of opinion among investors as well as short-sales constraints. The key insight that emerges is that breadth of ownership is a valuation indicator. When breadth is low i.e., when few investors have long positions in the stock this signals that the short-sales constraint is binding tightly, implying that prices are high relative to fundamentals and that expected returns are therefore low. Thus reductions in breadth should forecast lower returns, while increases in breadth should forecast higher returns. Using quarterly data on mutual fund holdings over the period 1979-1998, we find evidence supportive of this prediction: stocks whose change in breadth in the prior quarter places them in the lowest decile of the sample underperform those in the top change-in-breadth decile by 6.38% in the first twelve months after portfolio formation. After adjusting for size, book-tomarket and momentum, the corresponding figure is 4.95%. We are grateful to the National Science Foundation and the Division of Research at Harvard Business School for research support. A special thanks to Ken Froot for his insightful comments on our earlier work, which helped to spark our interest in the topic of this paper. Thanks also to the referee (Ken French), to Kent Daniel, Owen Lamont and Andrei Shleifer, and to seminar participants at Duke, the University of North Carolina, Yale, the NBER, London Business School, the Federal Reserve Bank of New York, Harvard, Vanderbilt, USC, Michigan, Princeton and the University of Texas Finance Festival for helpful suggestions.