Boyd: I missed the article. As to comments, I have written a lot about this subject in the past, and no doubt will have more to say in the future. I will try to be brief, for now. Please forgive any errors in details.
A few years ago, a colleague faxed me two articles from the then current issue of Forbes. One article declared that a recent study proved that Value Investing does not work. The other article, citing the same data, declared that it proved that Value Investing does work. (Btw, I vaguely recall that the author of the second article was Laszlo Birinyi.)
Michael O'Shaughnessy, author of What Has Worked On Wall Street did research that starts in 1926, as the first outside investigator to be given access to all of S&P's data going back to that year. His unequivocal conclusion is that Value wins in the long run. In particular, he identified low price-to-sales ratio as beating the pants off high price-to-sales ratio.
Personally, I put very little faith in back testing what I call "magic formulas" for determining Value, momentum, or whatever. The only demonstrations that interest me are those wherein the choices were made prospectively -- for example, the track records of real life investment managers (not college professors back testing a data base). With back testing, there is too much tendency toward selection bias in what criteria are adopted. Further, the whole area presumes that Value Investing is about buying cheap because it's cheap. That's not what contemporary Value Investing is about. The idea is to buy cheap stocks in spite of their being cheap. (To be fair to momentum or growth investing, they may be selecting high priced stocks in spite of their being expensive.)
A stock's p/e might be low because it's a cyclical company that has reached the peak earnings of its cycle. Conversely, it might have a high p/e because its earnings have bottomed. It might have a high p/e because it has a monopoly (MSFT). It might have a low p/e because its in an industry that's going down the tubes (BS).
Or, suppose a new manager takes over a below-market-p/e company. Michael Armstrong had a great track record at GM Hughes before coming to AT&T. Whereas, Al Dunlap had butchered (and then sold to suckers) the companies he had been at before arriving at Sunbeam.
Selection criteria for comparing "Value" with "growth" strategies are unlikely to make these distinctions. In my view, there is no formula that eliminates the need for sound judgment, based upon study and experience, to successfully implement any investment strategy. The most recent "magic-formula" related financial catastrophe was Long Term Capital Management. But, it is only the latest in a very long list.
Btw, the 1963 to 1995 period that Loughran studied was a period during which Buffett outperformed the S&P 500 by over 10% annually. |
