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Bloopers & Blunders: Dial Stock Underperformed

"Shares of Dial have underperformed the stock market since the end of 1991, according to Baseline, a New York financial-data service. In that period, Dial’s stock was up 41% through Wednesday, compared with a 61% jump in Standard & Poor’s 500-stock index." (WSJ, 2/16/96, p. A3)

INTRODUCTORY LEVEL

The business press talks about outperforming the market based only on comparing actual return on an asset to a benchmark such as the S&P 500 index. A more sensible approach is that of finance textbooks that also incorporate risk. Financial pricing models, such as the Capital Asset Pricing Model (CAPM), provide investors with a tool to guide them as to what a "fair" or minimum acceptable rate of return should be. Once you have this benchmark, then you can examine actual performance and compare it to what a model would have predicted.

 Thus, underperforming the market should mean the following: The stock under-rewarded (under-compensated) its investors for the amount of risk inherent in Dial; the actual returns were lower, on a risk-adjusted basis, than predicted by the model. Typically the CAPM is used to measure the risk-adjusted required return/reward.

 Non-academics would probably respond by saying that maybe the CAPM is an inadequate model, or at least has limitations. This might be a valid argument, but the issue remains that you need to include risk into comparisons. Just looking at return could be futile.

 INTERMEDIATE LEVEL

Dial underperforming the market means that its actual returns since 1991, on average, fell below the Security Market Line (SML). Thus, given Dial’s "beta", the average actual return would have been less than the required/expected return predicted by the CAPM. Without knowing beta, such a conclusion cannot be drawn from the article’s reference to underperforming.

By Alex Tajirian