What Is an Abnormal Rate of Return in the Stock Market?
An abnormal rate of return represents the earnings that a stock or portfolio generates over time that is more or less than an expected return. Stocks are assigned an expected return based on a capital asset pricing model (CAPM), which examines risk and rates of return in comparison with the broader financial markets.
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Considerations
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Abnormal rates of return in the stock market work to the upside and the downside. Whether the actual return that a stock or portfolio generates is above the expected rate of return or below it, the percentage difference is the abnormal rate of return.
Features
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There are various factors that can trigger unexpected surges and declines in a stock that drive performance further from the CAPM. Those factors in turn produce an abnormal rate of return. Unplanned events may include a hostile takeover, friendly merger, surprising earnings results and litigation.
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Types
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The broader financial markets are measured by performance in key indexes. In the U.S., the S&P 500 is considered the most broad barometer of the stock market because it represents 500 leading stocks across multiple industries. The S&P 500 may be used to calculate an expected return using the CAPM method.
History
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The technology boom of the late 1990s represents a period of abnormal rates of return for internet stocks. Many of these stocks, however, were trading at much higher levels than their earnings and some were unprofitable. Eventually, stock performance caught up with the unprofitable companies and many were forced into bankruptcy.
Warning
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Bernard Madoff, the mastermind behind the multibillion-dollar Ponzi scheme that duped hundreds of investors, claimed to produce unrealistic yearly returns of between 11 percent and 16 percent consistently for years, according to the New York Times. Such aggressive abnormal returns should raise reg flags to investors.
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- Photo Credit Image by Flickr.com, courtesy of Duncan Rawlinson
