Abstract
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 (increases) in breadth should forecast lower (higher) returns. Using quarterly data on mutual fund holdings over the period 1979-1998, we find evidence supportive of this predictions: 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-to-market and momentum, the corresponding figure is 4.95%.
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