JSE Power of Value, Part-I

In Benjamin Graham's 1934 classic "Security Analysis" David Dodd and he argued that out-of-favor stocks are mostly underpriced in the market, and that investors could capitalise on this phenomenon to reap strong returns. Conversely, prices for widely popular stocks often are propped by unrealistic expectations and thus vulnerable if these prove too enthusiastic. This philosophy formed the beginnings of what is now widely known as value investing.

The most common metrics to measure value stocks are Price/Book, Price/Earnings and Price/Cashflow. In 1994, academics Josef Lakonishok, Andrei Shleifer, and Robert Vishny published “Contrarian Investment, Extrapolation, and Risk,” a seminal entry in the value investing research field. Using data from 1968 to 1989 they grouped U.S. stocks into decile (ten) segments ranked on price-to-book,price-to-cash flow, and price-to-earnings ratios. The research created 22 sets of deciles, and tracked 5 years of decile-by-decile performance for each price-to-x criteria. They concluded that value deciles based on low price-to-x values consistantly outperformed "glamour" deciles with high price-to-x values, by wide margins, as shown below with the Price-to-book example:

Eugene Fama of the University of Chicago’s Graduate School of Business and Kenneth French from MIT’s Sloan School of Management tackled a similar question in 1998’s “Value versus Growth: The International Evidence.” The researchers found that, from 1975 to 1995, value stocks outperformed glamour stocks in 12 of 13 major national equity markets. In their opinion, this laid to rest the possibility that the value outperformance noted by Lakonishok, Shleifer and Vishny was sample-specific happenstance. “Rather than being unusual,” Fama and French concluded, “the higher average returns on value stocks in the United States are a local manifestation of a global phenomenon.”

NEXT : Power of Value on the JSE, Part-II