Certain stocks are poised to lose money, even if the broader U.S. stock market stops declining and begins rising again. A recent study titled “The Dynamics of Disagreement” sheds light on why some stocks consistently underperform, regardless of overall market trends.
Key Findings from the Study
Conducted by Kent Daniel of Columbia Business School, Alexander Klos of Germany’s Kiel University, and Simon Rottke of the University of Amsterdam, the research highlights the role of short-selling constraints in stock performance. Stocks that are difficult or expensive to borrow for short-selling tend to be overvalued, making them likely to underperform over time.
Case Study: GameStop’s 2021 Surge and Fall
One of the most notable examples of this phenomenon was GameStop (GME) in early 2021. As retail traders fueled the stock’s meteoric rise, many institutional short sellers struggled to borrow shares. This lack of short-selling pressure contributed to an inflated price, setting the stage for significant underperformance in the years that followed. Four years later, GameStop’s stock price is down 81% from its split-adjusted peak in January 2021.
Two Groups of Hard-to-Short Stocks That Underperform
The study categorizes underperforming stocks into two key groups:
- Constrained Winners: Stocks that have surged in the past year but are difficult to short. These stocks, like GameStop, tend to lag behind the market for up to five years after their peak.
- Constrained Losers: Stocks that have declined significantly in the past year and remain hard to short. While they also tend to underperform, their lag typically lasts for about 12 months rather than five years.
Real-World Market Performance
Applying this methodology to stocks within the S&P 1500, the latest analysis published in April 2024 reinforced these findings. As of March 10, 2025:
- The Constrained Winners category saw an average loss of 8.4%.
- The Constrained Losers category experienced an average decline of 9.3%.
- Meanwhile, the S&P 500 posted a total return gain of 9.3% over the same period.
Implications for Investors
This study underscores the importance of understanding short-selling constraints when evaluating stock investments. Stocks that are difficult to short often see inflated valuations, making them vulnerable to future underperformance. By identifying Constrained Winners and Constrained Losers, investors can make more informed decisions and mitigate potential losses.
