Laggard

What Is Laggard?

A laggard in finance refers to an investment, such as a stock, security, or an entire market sector, that consistently underperforms relative to its benchmark or peers over a specific period. This concept is a core element of financial performance analysis and portfolio management, highlighting investments that yield lower-than-average returns compared to what is expected given market conditions or the performance of comparable assets. Identifying a laggard is crucial for investors assessing the health and potential of their portfolio, as these assets can drag down overall performance.

History and Origin

The term "laggard" has long been used in a general sense to describe something or someone falling behind. Its application in finance gained prominence as investment analysis evolved, particularly with the widespread adoption of benchmarks and comparative performance metrics. As financial markets became more sophisticated and data-driven, the ability to measure and compare the performance of individual assets and sectors against broader indices or peer groups became standard practice. This allowed analysts and investors to formally identify and categorize assets exhibiting consistent underperformance.

A notable historical example of a company becoming a laggard due to a failure to adapt is Blockbuster. Once a dominant force in video rentals, Blockbuster famously declined to purchase Netflix for $50 million in 2000, dismissing the nascent online DVD-by-mail service.¹⁹,¹⁸ While Blockbuster later attempted to launch its own online services, these efforts were too late and too costly to reverse its trajectory, ultimately leading to bankruptcy as Netflix, its former laggard in the digital space, soared in market valuation.¹⁷,¹⁶

Key Takeaways

• A laggard is an investment that consistently underperforms its benchmark or peers.
• Holding laggards in a portfolio can reduce overall returns and may indicate underlying issues with the asset or market conditions.
• Investors often identify laggards to consider selling them, although some laggards may represent potential turnaround opportunities.
• Identifying laggards is a key part of active portfolio management and strategic adjustments.
• Laggard status can be temporary, influenced by economic cycles or company-specific challenges, or it can indicate a more permanent decline.¹⁵

Interpreting the Laggard

Interpreting whether an asset is a true laggard requires careful analysis beyond simply observing negative returns. It involves comparing its performance to relevant benchmarks, such as a market index like the S&P 500, or a peer group of similar companies or funds. For example, a stock might have positive returns but still be considered a laggard if its peers or the overall market have significantly higher returns during the same period. This relative performance context is vital.

The reasons for an asset becoming a laggard are varied and can include poor management decisions, declining revenue, high debt burdens, increased competition, or adverse regulatory changes.¹⁴ Investors typically look at metrics like revenue growth, profitability, and debt ratios to understand the causes of underperformance. Understanding the root causes helps in determining whether the laggard status is a temporary setback, potentially offering a value opportunity, or a sign of a fundamental, long-term decline. This assessment helps inform an appropriate investment strategy.

Hypothetical Example

Consider two hypothetical technology companies, TechCorp A and Innovate Inc., both operating in the same sub-sector. In a given year, the average return for this tech sub-sector is 15%.

• TechCorp A: Reports an annual return of 8%.
• Innovate Inc.: Reports an annual return of 18%.

In this scenario, TechCorp A would be considered a laggard. Despite having a positive return, its 8% gain falls significantly short of both the sub-sector average of 15% and Innovate Inc.'s 18% return. This indicates that TechCorp A is underperforming relative to its industry peers and the broader market for its category. An investor holding TechCorp A would see its investment return erode potential portfolio gains compared to holding better-performing assets in the same segment.

Practical Applications

Identifying laggards is a fundamental aspect of active portfolio management and market analysis across various financial contexts.

• Portfolio Management: For investors and fund managers, actively monitoring investments to identify laggards is crucial for maintaining a healthy portfolio. Assets consistently showing underperformance might be candidates for divestment, allowing capital to be reallocated to more promising opportunities or for diversification purposes. This process involves regular portfolio reviews and performance attribution analysis.
• Sector Analysis: Analysts often categorize entire market sectors as laggards. For instance, the consumer staples sector has, at times, been considered a laggard in terms of shareholder performance compared to other sectors, particularly when investors favor higher-growth stocks.¹³,¹² This kind of broad underperformance can be due to shifting consumer preferences, supply chain issues, or an erosion of traditional scale advantages.¹¹
• Investment Decision-Making: Recognizing a laggard can prompt different investment decisions. Some investors might view a laggard as a potential "bargain" if they believe the reasons for its underperformance are temporary and a turnaround is imminent, often referred to as a "turnaround story." Others may see it as a signal to avoid the asset due to persistent risks.
• Market Volatility Indicators: In broader markets, persistent underperformance by a significant segment of stocks or sectors can sometimes precede or accompany periods of market volatility, prompting regulators and market participants to assess underlying risks. The U.S. Securities and Exchange Commission (SEC) actively monitors market volatility and implements measures to maintain fair and orderly markets.¹⁰,⁹

Limitations and Criticisms

While identifying a laggard can be a straightforward comparison of returns, interpreting its implications has several limitations and criticisms:

• Temporary vs. Structural: A primary challenge is discerning whether a laggard's underperformance is temporary (e.g., due to short-term economic headwinds, a specific product cycle, or market sentiment) or structural (e.g., outdated business model, consistent mismanagement, or irreversible industry disruption). Mistaking a structurally flawed company for a temporary laggard can lead to prolonged capital allocation to a losing asset.
• Value Traps: Sometimes, what appears to be an undervalued laggard is, in fact, a "value trap"—a stock that looks cheap but continues to decline due to fundamental issues. Investors might be drawn to a laggard with the hope of a quick rebound, only to find their investment further depreciates.
• Confirmation Bias: Investors may exhibit confirmation bias, holding onto a laggard longer than prudent due to an initial belief in its recovery, overlooking mounting evidence of continued decline.
• Higher Fees in Active Management: Critically, some research suggests that active management, which often attempts to identify and avoid laggards or find turnaround stories, frequently fails to outperform passive strategies over long time horizons. Morningstar research indicates that a significant majority of actively managed funds have underperformed their passive counterparts, particularly in categories like large-cap equities., ⁸T⁷his implies that the costs associated with active management, including higher fees, can negate any potential benefits of identifying and avoiding individual laggards, making passive investing via low-cost index funds a more effective long-term strategy for many.

Laggard vs. Leader

The terms "laggard" and "leader" are antonyms in financial analysis, used to describe relative performance within a market or sector.

While a laggard is an investment that has consistently fallen behind, a leader (or "outperformer") is one that consistently surpasses its peers or the market. The distinction helps investors evaluate past performance and inform future investment decisions. Investors generally aim to identify leaders and divest from laggards, though some strategies focus on identifying potential "laggard-to-leader" turnarounds.

FAQs

What causes a stock to become a laggard?

A stock can become a laggard for various reasons, including consistently missing earnings or sales estimates, shaky fundamentals, poor management decisions, increased competition, or broader economic headwinds affecting its industry.,
^4
3### Should I sell a laggard in my portfolio?

The decision to sell a laggard depends on the reasons for its underperformance and your overall investment strategy. If the underperformance is due to temporary factors and you believe in the company's long-term prospects, holding may be justified. However, if the issues are fundamental or structural, selling the laggard could be prudent to reallocate capital to more promising investments and improve overall portfolio return.

Can a laggard become a leader?

Yes, a laggard can sometimes become a leader, particularly if its underperformance was due to temporary setbacks that are subsequently resolved. Companies facing temporary challenges due to economic cycles or shifts in consumer behavior may rebound. Identifying such "turnaround stories" requires thorough analysis of the company's fundamentals, management, and industry outlook. H²istorically, the laggards of one year have sometimes become leaders in the following year, though this is not a consistent pattern.

¹### How does market volatility affect laggards?

Market volatility can exacerbate the underperformance of laggards. During periods of high market uncertainty, investors often gravitate towards more stable, higher-quality assets, further punishing those already perceived as weak or underperforming. Conversely, a return to stability might provide a more favorable environment for some laggards to begin a recovery.