This paper is a distillation of 50 major investment studies that the firm Tweedy, Browne has reviewed, and has served as the basis for their investment strategy. They claim the characteristics for equity outperformance are repeatable and robust, because they exploit typical investor behavioral mistakes. Since “value” strategies have underperformed over the past decade, it questions whether investors have wizened up to the so-called “value premium”. Tweedy acknowledges that unlike science, in investments, no single or combination of criteria can produce great returns all the time. The bulk of the studies weigh convincingly though: over longer periods of time, cheap stocks of stable—particularly small—companies have demonstrated favorable odds.
- Low Price to Assets
- Low NCAV (purchased at < 66%) has outperformed strongly over time. In 1986 Oppenheimer study, stocks of unprofitable companies performed comparably to those of profitable ones, due to real property and fixed assets being generally undervalued by the market (and unvalued by the NCAV formula).
- Low P/B: many studies have consistently shown low P/B outperforming high P/B, monotonically across increasing quantiles, and even more powerfully when combined with low market cap. The effects are more pronounced for recent earnings underperformers with low debt. Low P/B performed especially well in down markets, suggesting the return premium is not driven by higher risk. The low P/B effect is robust across the time periods studied (1960s – 2000s) and both within and across international developed markets.
- Low Price to Earnings
- Low P/E: echoing low P/B, multiple similar studies show low P/E stocks exhibit robust excess returns.
- Low P/CF: similar to low P/B and P/E for excess return. CF advantage is it helps identify ‘hidden value’ companies whose earnings are understated (e.g. international companies with large depreciation not reporting according to GAAP)
- Low Price/ Dividend (i.e. High Dividend Yield): tends to be associated with low P/E. The highest yields should be coupled with low payout ratio. Weakest of the popular value strategies overall, but most defensive in bear markets.
- Insider Purchases: people with insight information
- Company officers and directors often buy their own stock if it’s unfairly depressed, especially with a near-term catalyst. Several studies have found excess returns from following intense insider buying, particularly strong about a year after their initial purchases.
- Significant Decline in Stock Price: usually from recent earnings disappointment
- A few studies have found investor over-reaction. The worst performing stocks over the preceding 4-5 years turn out to outperform the best performing stocks, over the next 2-4 years, showing evidence of earnings and price mean reversion. Also observed internationally.
- Small Caps: higher growth rates and chances for acquisition
- Various studies, across several developed markets, have consistently shown smaller cap stocks outperforming larger caps, usually with decile 10 outperforming dramatically.
Finished: 15-Mar-2019. Rating: 7/10.