The idea that you need 160 stocks to diversify is simply ludicrous. The chart below shows diversification benefits can largely be achieved with 30-40 stock portfolios. That is to say, you can have a return profile with roughly the same volatility as the overall equity market by holding around 30-40 stocks.
An alternative perspective is provided by showing the percentage of non-market risk that is eliminated as the number of stocks in the portfolio increases. This is shown in the chart below. Holding two stocks eliminates around 42% of the risk of owning just one stock, holding four stocks this is reduced by 68%, by 83% by holding 8 stocks, by 91% by holding 16 stocks, by 96% by holding 32 stocks. This relationship is graphed in the chart below. Holding two stocks eliminates around 42% of the risk of owning just one stock, holding four stocks this is reduced by 68%, by 83% by holding 8 stocks, by 91% by holding 16 stocks, by 96% by holding 32 stocks.
Friday, June 29, 2007
Live off your investments
Someday, your portfolio will earn more than you do.
Sure, that day may be a long way off, especially if you've just started saving for retirement. But little by little, month after month, as you save more, your investments will earn more. As you increasingly benefit from the magic of compound interest, your portfolio value will climb higher and higher. Eventually, you'll see your account balances rise and fall with the market by amounts that represent months of pay. By then, you may wonder why you're still working at all.
Sure, that day may be a long way off, especially if you've just started saving for retirement. But little by little, month after month, as you save more, your investments will earn more. As you increasingly benefit from the magic of compound interest, your portfolio value will climb higher and higher. Eventually, you'll see your account balances rise and fall with the market by amounts that represent months of pay. By then, you may wonder why you're still working at all.
Is Large Growth Now Cheap?
[7/18/07] Large caps have underperformed small caps in seven out of the last eight calendar years. [So it's due?...]
[6/28/07] Is This the Moment for Large-Cap Stocks? I'll put that question to Ron Canakaris of Aston/Montag & Caldwell Growth (MCGFX). I know what Canakaris' view will be. He recently wrote to shareholders and told them that "Now's the time!" He argued that after a very long run for small caps, the tide would turn: "The outperformance of large cap value over large cap growth has continued for an unprecedented seven years. As investment returns normalize for these two asset categories, relative returns should favor growth by a substantial margin. As a result of these performance differences, significant valuation gaps have developed. For example, the relative price to earnings multiple of the largest twenty-five companies in the S&P 500 is at one of its lowest points in twenty years and the Russell 1000 Growth's price to sales ratio relative to the Russell 1000 Value's ratio is at its lowest point since 1980. Furthermore, your equity holdings are particularly attractive at this time. As of 12/31/06 your equities were selling at a median price to present value ratio of 76%, or at a 24% discount to our calculated intrinsic value."
[4/2/07 via russ] Sometimes what you're looking for is hidden in plain sight. And if what you're looking for are some long-term conservative investments at good value, that's the case right now.
While everyone else is off hunting emerging-market equities and high-yield bonds, take a look at something really simple and obvious:
The article goes on to mention some of the growth picks Bill Nygren has been adding to his Oakmark Fund, Wal-Mart, Citigroup, Abbott Laboratories, Harley-Davidson, Home Depot. "He expects them all to not only show strong earnings growth, but also to benefit as investors become more willing to pay up for solid growth propects and send their P/E ratios higher.
[6/28/07] Is This the Moment for Large-Cap Stocks? I'll put that question to Ron Canakaris of Aston/Montag & Caldwell Growth (MCGFX). I know what Canakaris' view will be. He recently wrote to shareholders and told them that "Now's the time!" He argued that after a very long run for small caps, the tide would turn: "The outperformance of large cap value over large cap growth has continued for an unprecedented seven years. As investment returns normalize for these two asset categories, relative returns should favor growth by a substantial margin. As a result of these performance differences, significant valuation gaps have developed. For example, the relative price to earnings multiple of the largest twenty-five companies in the S&P 500 is at one of its lowest points in twenty years and the Russell 1000 Growth's price to sales ratio relative to the Russell 1000 Value's ratio is at its lowest point since 1980. Furthermore, your equity holdings are particularly attractive at this time. As of 12/31/06 your equities were selling at a median price to present value ratio of 76%, or at a 24% discount to our calculated intrinsic value."
[4/2/07 via russ] Sometimes what you're looking for is hidden in plain sight. And if what you're looking for are some long-term conservative investments at good value, that's the case right now.
While everyone else is off hunting emerging-market equities and high-yield bonds, take a look at something really simple and obvious:
Blue chip U.S. equities.
Yep, the companies everyone knows, like Johnson & Johnson (JNJ - Cramer's Take - Stockpickr - Rating), Procter & Gamble (PG - Cramer's Take - Stockpickr - Rating), IBM (IBM - Cramer's Take - Stockpickr - Rating), Intel (INTC - Cramer's Take - Stockpickr - Rating) and Citigroup (C - Cramer's Take - Stockpickr - Rating).
These are the world's biggest, best run, and most respected companies. They're global. They have underperformed the rest of the stock market, here and abroad, for years.
And that means today they are looking like pretty reasonable values -- especially compared to almost everything else
[3/23/07 via russ] After a seven-year run value stocks are pricier than ever. When Jeremy Grantham says that, it's time to think about buying growth stocks instead.
[7/9/06] In the bull market of the late ’90s, large-company growth stocks, and technology stocks in particular, enjoyed one of their most extended and significant periods of superior performance. Since that bubble burst in 2000, however, large-cap growth stocks have been perennial market laggards, trailing small-cap and value-oriented stocks in each of the past five years through 2004.
Several T. Rowe Price portfolio managers believe that stocks of higher-quality, large-cap companies may be poised to outperform. While small-cap stocks have outperformed in recent years, larger companies have generally had better earnings growth, so their relative valuations appear attractive. At the end of March [2005], small-cap stocks on average sold at a modest valuation premium to large-cap stocks, with the median P/E (price-earnings) ratio for large companies at 16.4X operating earnings compared with 16.6X for small-cap companies. Since 1983, small-caps have sold at a median P/E discount to large-caps of about 2%, according to The Leuthold Group, a market research firm. At the end of 1999, small-caps sold at an extreme 40% discount to large-cap stocks.
Large-cap growth stocks are also relatively attractive compared with large-cap value stocks. The Russell 1000 Growth Index has moved below its historic average P/E premium relative to the Russell 1000 Value Index. In addition, Leuthold observes that large-cap growth stocks, with a P/E ratio of 20.0X in March, are 7% below their historical average P/E, while large-cap value stocks (at 11.8X) are 18% above their historical average P/E.
-- T. Rowe Price Report, Spring 2005
[4/13/06] Tom Gardner says value ratios for small caps are flashing a yellow light (but not red yet).
[3/24/06] "The only thing I know for sure is that we're in a dramatically better place than in 1998 because we're getting a lot more earnings per dollar invested. ... In 1999 the largest 50 companie in the S&P 5000 traded at a 168 percent premium to the next 450 companies. Today the top 50 trade at a 5 percent discount to the next 450, and the big companies with strong balance sheets, globally diverse portfolios, high dividend yields and powerful brands are the cheapest. Statistically, it looks like the largest companies are at the lowest relative valuations they've been at in 10 or 15 years." -- Chris Davis, in the March 2006 SmartMoney.
[3/22/06] It's been seven years since growth stocks had their day in the sun. That's why many market-watchers think the time is ripe for this group of stocks to come back strong. To find a few companies that might offer good opportunities, we asked Morningstar, the Chicago research firm, to find some attractively priced growth companies.
[3/20/06] In the April SmartMoney, Jack Hough reports on James O'Shaughnessy's new book. While many are predicting that large-company stocks should start outperforming again, "O'Shaughnessey is calling for returns of 3 to 5 percent a year, after inflation, for the next 15 years." Shares of small companies, he argues, will do much better with real returns of 8-10%.
[3/20/06] There's an interesting link in this article on Emerging Market ETFs. It's a chart ranking the various asset classes for each of the last 15 years. I note that Large Growth did quite well for six straight years from 1994-1999. Then went on to do quite poorly for the next six years from 2000-2005. Small value did well from 2000-2004, then fell to the middle of the pack in 2005. Emerging growth had the worst or second worst performance in six of the seven years from 1994-2000. But it had the best performance in 1993 and 1999 and has been hot since 2003.
[3/16/06] Jeremy Grantham says "Growth stocks are merely badly overpriced--down from legendary levels--but value stocks, which were only a tiny bit overpriced, are now at least as badly overpriced as growth stocks."
[2/15/06] The current rally has made small caps less attractive from a fundamental valuation perspective, [Steven Leuthold] said. When small caps began to rise, they were 40 percent cheaper than large caps, according to measures like the price-to-earnings ratio. Today, Mr. Leuthold said, they are about 10 percent more expensive.
Worse yet, he said, their earnings momentum has slowed. And this fundamental deterioration has begun to show up in trading patterns. For the first time in six years, fewer than 50 percent of small caps are outperforming the Standard & Poor's 500-stock index, he said.
[2/12/06] Howard Ward believe the cycle is turning for large cap growth stocks. (Of course, the fact that he's the manager of a large cap growth fund may have something to do with it.)
[2/3/06] Schwab is now advising clients to overweight both large- and small-cap growth stocks relative to value stocks.
[1/2/06, Robert Hagstrom in the LMGTX quarterly report] Since the beginning of 2004, the stock market has bifurcated and we have found ourselves temporarily on the wrong side of the divide. I underscored the word ‘‘temporarily’’ because I firmly believe the relative outperformance of value stocks (which overwhelmingly include energy and utility stocks) to growth stocks (which overwhelmingly include consumer discretionary and technology stocks), will soon reverse. Of course, there is no assurance that this will occur.
Value stocks outperforming growth stocks and small-capitalization stocks beating largecapitalization stocks have now entered its sixth consecutive year. It has been an unprecedented period of relative underperformance by large-cap growth companies. We opined in our last commentary the market pendulum would soon begin to shift from defensive stocks to offensive stocks and from smaller-capitalization stocks to larger-capitalization stocks. Although this has occurred in baby steps over the past two quarters, we believe more substantial gains lie ahead for large-cap growth stocks.
... At present, growth stocks and value stocks trade at similar prices and that is very unusual. The reason why growth stocks should trade at higher multiples than value stocks is based on the differential economic returns for the two groups. Typically, growth stocks have higher growth rates, higher profitability and higher returns on capital compared to value stocks. In an efficient market, value stocks should trade at lower price earnings ratios because they achieve economic returns that are below the economic returns earned by growth stocks.
... Since 1978, the price to earnings ratios of value stocks compared to growth stocks has averaged about .65. At the end of the 1990s, the price earnings ratio of value stocks dipped to .32. By the end of 2004, this ratio reached .75—a 134% increase in valuation. Once again, value stock price earnings ratios compared to growth stocks are at a two-decade high.
* * *
[1/2/06, from Wally Weitz in the WVALX semi-annual report] As we have discussed in recent letters, several of the new stocks we have been buying look suspiciously like traditional “growth” stocks—e.g. Wal-Mart. High-quality companies with predictable earnings growth are generally not available at prices we are willing to pay. These stocks may be more affordable today because investors fled “growth” funds after having been burned in the collapse of the tech bubble and moved to “value” funds that had performed better during the bear market. It may also be that investors have sold these “blue chips” to buy commodity companies (especially energy), utilities and real estate stocks.
Grantham, Mayo, Van Otterloo (GMO), a quantitatively oriented investment firm, wrote about this phenomenon in a July, 2005 report. They point out that from January, 2000 through June, 2005, “value” stocks (which they define as the half of all stocks with less than the median price/earnings or price/sales ratios) out-performed “growth” stocks by 138%. According to their study, “value” is now less cheap relative to “growth” than at any other time in the past 27 years. They also found that “high quality” stocks (as measured by stability of earnings and balance sheet strength) were the cheapest relative to lower quality stocks than at any other time during the study.
This study does not prove that these stocks will do well, but it does help to explain why new faces are showing up in our portfolios. Wal-Mart, AIG, Anheuser-Busch, WellPoint, UnitedHealthcare and several other newcomers were selling at discounts to our estimates of their business values, and that is what attracted us.
* * *
[12/8/05] At the Value Investing Congress, held in New York City and attended by more than 400 investors, one major theme was the appeal of large-cap blue-chip stocks. Increasingly, investors appear to be starting to define these as "value" stocks.
[12/5/05] After beating the big boys for five years in a row, the small stock miracle may be ending -- for now (says CNNMoney).
[9/21/05] For the last five years, small-cap value funds have outperformed their larger counterparts. When one asset class outperforms another over an extended period, the result may be an imbalance in your portfolio, suggesting that now may be a good time to evaluate whether your large-cap growth allocation is underweight.
[8/30/05] Small-cap stocks have outperformed large caps ever since the tech bubble burst back in 2000, and for arguably the right reason -- small cap stocks had much lower valuation multiples. But from the bottom-up perspective of Schwab Equity Ratings, small-cap stocks are no longer a bargain.
During the March 2003 market bottom, the proportion of small-cap stocks that were given an A rating by Schwab Equity Ratings was about 34% near an all-time high, suggesting unusual value was still present in the small-cap sector at that time. Over the subsequent year, the small-cap Russell 2000 index outperformed the large-cap S&P 500 index by 26%.
But now large caps represent about 60% of A-rated stocks while the proportion of small caps has fallen to around 14%, near all-time lows. Since 1986, the only two times large caps constituted over 60% of A-rated stocks were September 30, 1994, and May 31, 1998. After each of those dates, the S&P 500 outperformed the Russell 2000 by an average 16% over the subsequent 12 months and 22% over the subsequent 18 months. Our research suggests that now might be a good time to take some profits in small caps and consider rebalancing your stock portfolio toward large-cap stocks. (Greg Forsythe, On Investing Magazine, Summer 2005).
* * *
[8/21/05] When Growth Is a Value: Since February 2002, the large growth issues are off 40 percent while value equities are trading higher by 50 percent. That disparate performance has made growth much cheaper than usual. As Leuthold notes, the multiple on large-cap growth, at 23.5 times, is 5 percent below its historical average, while the multiple on large-cap value, at 11.9 times, is 19 percent above its historical average. Devoted followers of the "buy cheap" doctrine with a sense of history should be looking at large-cap growth. (ref: chucks_angels post)
* * *
[7/22/05] In line with the thought that growth stocks may be due to come back into vogue is an article in the July 2005 SmartMoney entitled "The Sweet Spot".
In the late 1990s -- the days of outsize expectations -- investors bid up growth stocks to outrageous levels, relative to value. The Russell 2000 Growth Index peaked in June 2000 at a p/e ratio of 128; the index's value counterpart warranted a multiple of just 14. These days, though, the growth index carries a p/e of 21, while the value index has a p/e of 17. Same goes for funds, says Lipper analyst Andrew Clark. "Fund P/Es in terms of growth and value are almost on top of each other these days," he says.
"This is the most extreme swing," says Harry Lange, manager of Fidelity Capital Appreciation, who says that his fund has become "increasingly growth," with names such as Dell, Genentech, and Univsion added in the past year. "Growth hasn't been this cheap in 30 years. A lot of these stocks have been beaten down so much, we're looking for pretty big runs -- a 50 percent increase in most cases."
The article goes on to mention some of the growth picks Bill Nygren has been adding to his Oakmark Fund, Wal-Mart, Citigroup, Abbott Laboratories, Harley-Davidson, Home Depot. "He expects them all to not only show strong earnings growth, but also to benefit as investors become more willing to pay up for solid growth propects and send their P/E ratios higher.
Thursday, June 28, 2007
Valuation Spreads
David Nelson of Legg Mason writes about a historical chart of valuation spreads, which compares the top quintile of stocks (the cheapest 20%) to the market average.
As is visually apparent from the chart, valuation spreads are about as compressed now as they have been at any time since 1952. Spreads were similarly-but not as consistently-compressed for much of the 1960s and in the mid-to-late 1990s.
Goldstein's chart raises a couple of interesting questions, in our view. First, what is the investment significance of spread compression? And second, can we learn anything about the current market environment from analyzing past periods of valuation spread compression? I believe the answer to the second question is yes, but before we get to that, we need to answer the first.
Based on visual inspection of the chart and my own market experience, valuation spreads tend to be widest at, or near, major market bottoms-1974, 1982, 1991 and 2002. These are normally periods of high stress in the market, where most stocks are going down, but some sectors are getting absolutely killed. As this happens, the spread between the very cheapest stocks in the market and the average stock tends to widen out. In these environments, historically, the best investment strategy - though often the most painful if you're early - has been to load up on the very cheapest stocks (which are usually concentrated in a few sectors) and wait. If you don't get fired by your clients for owning really scary stocks first, you normally make a lot of money as the market turns and valuation spreads begin to narrow.
In contrast, market environments where valuation spreads are compressed tend to occur after the market has been doing well for a period of time. As the market advances, pockets of severe undervaluation get identified and exploited. Ultimately, this process of identification and exploitation leads to a market, such as we have today, where everything is priced the same. Obviously, that last statement is a bit of an exaggeration, but the spirit of the comment is true, in my judgment. In many industries and sectors today, we see little valuation discrimination between the very best companies and the merely average.
In market environments where valuation spreads are compressed, it would seem to make sense to focus on high-quality, high-return businesses that can grow, because you don't have to pay a premium-or much of one-for them. In short, it seems to us that it should pay to focus on growth stocks. That proved to be true in the mid-to-late 1990s, as well as the 1960s.
As is visually apparent from the chart, valuation spreads are about as compressed now as they have been at any time since 1952. Spreads were similarly-but not as consistently-compressed for much of the 1960s and in the mid-to-late 1990s.
Goldstein's chart raises a couple of interesting questions, in our view. First, what is the investment significance of spread compression? And second, can we learn anything about the current market environment from analyzing past periods of valuation spread compression? I believe the answer to the second question is yes, but before we get to that, we need to answer the first.
Based on visual inspection of the chart and my own market experience, valuation spreads tend to be widest at, or near, major market bottoms-1974, 1982, 1991 and 2002. These are normally periods of high stress in the market, where most stocks are going down, but some sectors are getting absolutely killed. As this happens, the spread between the very cheapest stocks in the market and the average stock tends to widen out. In these environments, historically, the best investment strategy - though often the most painful if you're early - has been to load up on the very cheapest stocks (which are usually concentrated in a few sectors) and wait. If you don't get fired by your clients for owning really scary stocks first, you normally make a lot of money as the market turns and valuation spreads begin to narrow.
In contrast, market environments where valuation spreads are compressed tend to occur after the market has been doing well for a period of time. As the market advances, pockets of severe undervaluation get identified and exploited. Ultimately, this process of identification and exploitation leads to a market, such as we have today, where everything is priced the same. Obviously, that last statement is a bit of an exaggeration, but the spirit of the comment is true, in my judgment. In many industries and sectors today, we see little valuation discrimination between the very best companies and the merely average.
In market environments where valuation spreads are compressed, it would seem to make sense to focus on high-quality, high-return businesses that can grow, because you don't have to pay a premium-or much of one-for them. In short, it seems to us that it should pay to focus on growth stocks. That proved to be true in the mid-to-late 1990s, as well as the 1960s.
Wednesday, June 27, 2007
Value wins (and so do small caps)
[6/14/11] Zacks article on the Fama and French study.
[6/27/07] Research from Brandes Institute, updated from a previous report. "Out of favor stocks often are associated with companies experiencing hard times, operating in mature industries, or facing similarly adverse circumstances. Alternatively, fast-growing "glamour" firms frequently function in dynamic industries with a relatively high profile. This start contrast in attributes leads to a natural question: which stocks perform better, value or glamour?"
Research from Brandes Institute found that value stocks outperformace remained substantial, even when the study's samples was adjusted to include Nasdaq stocks and exclude micro caps. For example, annualized five-year returns for the lowest price-to-book (value) stocks in Nasdaq-inclusinve, cap-screened sample averaged 17.9% over the 1968 ti 2006 period, while returns for the highest price-to-book (glamour) stocks average 10.45.
[4/16/07] Way back in 1981, Rolf Banz published a paper in the Journal of Financial Economics demonstrating that over the long-term small caps tended to outperform large caps. However, that was pretty much the last time the small cap effect was seen! Using data from Ken French, the chart below shows vividly that in the pre-1981 the US small cap effect was pronounced, running at the rate of just under 4% p.a. In the period since the study was published small caps have outperformed large caps by only 0.4% p.a. (strangely enough indistinguishable from zero).
[3/30/07] The best type of stock to have owned over time is small-cap value. Here are the results for the 50 years from 1956 to 2005, as calculated by Eugene Fama and Kenneth French:
[12/3/06] Small cap value trumps large cap growth
[9/21/06] Ibbotson Associates did a study comparing the performance of value stocks, growth stocks, and the S&P 500 between 1968 and 2002. Their results are clear.
Ibbotson Associates did a study comparing the performance of value stocks, growth stocks, and the S&P 500 between 1968 and 2002. Their results are clear.
[8/3/06] If small caps are good, and value is good, then microcaps and deeper value should be better, right?
[7/29/06] Often, you'll hear that there are two types of investors, value and growth. The truth is there isn't much difference.
[1/13/06] What's 70 times better than the next Microsoft? Answer: unknown, boring companies
[1/13/06] The danger of buying large growth
[1/1/06] Small caps had a better year than large caps. Again. And value stocks outperformed growth stocks. Again.
[1/1/06] Not too surprisingly (when you think about it) the top 10 performing stocks of the past 10 years were generally small and obscure. Does that mean you should buy small and obscure stocks? Maybe. But you'd better do your homework. I'd wager many of the small and obscure stocks of ten years ago are now bankrupt.
[11/9/05] There is solid evidence that, as a group, small caps tend to outperform large caps. In his book Investment Fables, Professor Aswath Damodaran pulls together research pertaining to various investing strategies. Using data from Gene Fama and Ken French, Damodaran found that smaller stocks earned higher average annual returns than larger stocks of equivalent risk for the period 1927-2001. When comparing the smallest subset of stocks to the largest, the difference is considerable: 20% vs. 11.74% on a value-weighted basis, with an even greater difference on an equally weighted basis.
[8/4/05] A SmartMoney article on why value beats growth
[7/13/05] This study, by LLakonishok, Shleifer, and Vishny, found that "value stocks" or unloved, low-expectation nobodies outperformed high-priced, high-expectation "glamour stocks". A portfolio favoring high (cheap) E/Ps and low growth outperforms its glamour opposite by 11% per year.
[7/18/05] I wrote about this in January too :)
[5/7/05] Jeremy Siegel writes in the December 2004 Money that if you'd invested $1000 in 1957 in the 100 stocks in the S&P with the highest price-to-earnings ratios, and rebalanced annually, you'd have had $56,700 by 2003; if you'd have bought the 100 stocks with the lowest P/Es, you'd have had $425,700. [The S&P 500 index was created in 1957.]
[7/18/05] Hey I see already wrote about this in January.
[4/29/05] So why not just invest in small cap value stocks?
[4/8/05] Philip Durell, of the Motley Fool Inside Value newsletter, found that value outperformed growth from 12/68 to 12/02 (according to Ibbotson). Considering the source, no big surprise.
What's more surprising is that both value and growth outperformed the S&P 500. So what that tells me is that smaller cap stocks outperformed during that period.
Looking at the Ibbotson paper shows the groups were ranked in the following order: micro-cap value, small-cap value, mid-cap value, large-cap value, large-cap growth, mid-cap growth, small-cap growth, and micro-cap growth.
The next question I have is how they determined whether a stock was a growth or value stock. They split each category into two by their book/price ratio. Growth was considered low b/p and value was considered high b/p.
While I would consider a low p/b a value stock, I wouldn't consider a high p/b a growth stock. So to me this study is not comparing value to growth, it's comparing cheap to expensive. And so it makes sense that cheap wins.
But then one could argue that high p/b stocks are probably high growth stocks (investors have bid up the price because the stocks have been fast growing).
In any case, the ranking of the eight categories was an interesting finding.
[1/28/05] Nirvana and Xanadu: better than Hell
[1/18/05] Rick Munarriz duels Philip Durell in the ongoing growth vs. value debate
[1/14/05] This study found value stocks outperformed glamour stocks.
The term "low growth" kind of threw me. But I'll interpreted that as non-super-high-growth-stocks-that-are-selling-at-ridiculous-valuations.
[6/27/07] Research from Brandes Institute, updated from a previous report. "Out of favor stocks often are associated with companies experiencing hard times, operating in mature industries, or facing similarly adverse circumstances. Alternatively, fast-growing "glamour" firms frequently function in dynamic industries with a relatively high profile. This start contrast in attributes leads to a natural question: which stocks perform better, value or glamour?"
Research from Brandes Institute found that value stocks outperformace remained substantial, even when the study's samples was adjusted to include Nasdaq stocks and exclude micro caps. For example, annualized five-year returns for the lowest price-to-book (value) stocks in Nasdaq-inclusinve, cap-screened sample averaged 17.9% over the 1968 ti 2006 period, while returns for the highest price-to-book (glamour) stocks average 10.45.
[4/16/07] Way back in 1981, Rolf Banz published a paper in the Journal of Financial Economics demonstrating that over the long-term small caps tended to outperform large caps. However, that was pretty much the last time the small cap effect was seen! Using data from Ken French, the chart below shows vividly that in the pre-1981 the US small cap effect was pronounced, running at the rate of just under 4% p.a. In the period since the study was published small caps have outperformed large caps by only 0.4% p.a. (strangely enough indistinguishable from zero).
[3/30/07] The best type of stock to have owned over time is small-cap value. Here are the results for the 50 years from 1956 to 2005, as calculated by Eugene Fama and Kenneth French:
| Value | Growth | |
| Large caps | 13.3% | 9.7% |
| Small caps | 17.3% | 8.7% |
| Total Stock Market | 10.5% |
[12/3/06] Small cap value trumps large cap growth
[9/21/06] Ibbotson Associates did a study comparing the performance of value stocks, growth stocks, and the S&P 500 between 1968 and 2002. Their results are clear.
Ibbotson Associates did a study comparing the performance of value stocks, growth stocks, and the S&P 500 between 1968 and 2002. Their results are clear.
S&P 500 6.5%Investors focused on value finished with twice as much cash as the growthies, and four times as much as the plain-vanilla indexers. [So I guess the other lesson would be to not invest in the S&P 500.]
Growth 8.0%
Value 11.0%
[8/3/06] If small caps are good, and value is good, then microcaps and deeper value should be better, right?
[7/29/06] Often, you'll hear that there are two types of investors, value and growth. The truth is there isn't much difference.
[1/13/06] What's 70 times better than the next Microsoft? Answer: unknown, boring companies
[1/13/06] The danger of buying large growth
[1/1/06] Small caps had a better year than large caps. Again. And value stocks outperformed growth stocks. Again.
[1/1/06] Not too surprisingly (when you think about it) the top 10 performing stocks of the past 10 years were generally small and obscure. Does that mean you should buy small and obscure stocks? Maybe. But you'd better do your homework. I'd wager many of the small and obscure stocks of ten years ago are now bankrupt.
[11/9/05] There is solid evidence that, as a group, small caps tend to outperform large caps. In his book Investment Fables, Professor Aswath Damodaran pulls together research pertaining to various investing strategies. Using data from Gene Fama and Ken French, Damodaran found that smaller stocks earned higher average annual returns than larger stocks of equivalent risk for the period 1927-2001. When comparing the smallest subset of stocks to the largest, the difference is considerable: 20% vs. 11.74% on a value-weighted basis, with an even greater difference on an equally weighted basis.
[8/4/05] A SmartMoney article on why value beats growth
[7/13/05] This study, by LLakonishok, Shleifer, and Vishny, found that "value stocks" or unloved, low-expectation nobodies outperformed high-priced, high-expectation "glamour stocks". A portfolio favoring high (cheap) E/Ps and low growth outperforms its glamour opposite by 11% per year.
[7/18/05] I wrote about this in January too :)
[5/7/05] Jeremy Siegel writes in the December 2004 Money that if you'd invested $1000 in 1957 in the 100 stocks in the S&P with the highest price-to-earnings ratios, and rebalanced annually, you'd have had $56,700 by 2003; if you'd have bought the 100 stocks with the lowest P/Es, you'd have had $425,700. [The S&P 500 index was created in 1957.]
[7/18/05] Hey I see already wrote about this in January.
[4/29/05] So why not just invest in small cap value stocks?
[4/8/05] Philip Durell, of the Motley Fool Inside Value newsletter, found that value outperformed growth from 12/68 to 12/02 (according to Ibbotson). Considering the source, no big surprise.
What's more surprising is that both value and growth outperformed the S&P 500. So what that tells me is that smaller cap stocks outperformed during that period.
Looking at the Ibbotson paper shows the groups were ranked in the following order: micro-cap value, small-cap value, mid-cap value, large-cap value, large-cap growth, mid-cap growth, small-cap growth, and micro-cap growth.
The next question I have is how they determined whether a stock was a growth or value stock. They split each category into two by their book/price ratio. Growth was considered low b/p and value was considered high b/p.
While I would consider a low p/b a value stock, I wouldn't consider a high p/b a growth stock. So to me this study is not comparing value to growth, it's comparing cheap to expensive. And so it makes sense that cheap wins.
But then one could argue that high p/b stocks are probably high growth stocks (investors have bid up the price because the stocks have been fast growing).
In any case, the ranking of the eight categories was an interesting finding.
[1/28/05] Nirvana and Xanadu: better than Hell
[1/18/05] Rick Munarriz duels Philip Durell in the ongoing growth vs. value debate
[1/14/05] This study found value stocks outperformed glamour stocks.
The term "low growth" kind of threw me. But I'll interpreted that as non-super-high-growth-stocks-that-are-selling-at-ridiculous-valuations.
Thursday, June 21, 2007
What’s the Right Time to Invest?
Imagine for a moment that you’ve just received a year-end bonus or income tax refund. You’re not sure whether to invest now or wait. After all, the market recently hit an all-time high. Now imagine that you face this kind of decision every year—sometimes in up markets, other times in downdrafts. What’s a good rule of thumb to follow?
Our research definitively shows that the cost of waiting for the perfect moment to invest far exceeds the benefit of even perfect timing. And because timing the market perfectly is, well, about as likely as winning the lottery, the best strategy for most of us mere mortal investors is not to try to market-time at all. Instead, make a plan and invest as soon as possible.
Five investing styles
But don’t take my word for it. Consider our research on the performance of five long-term investors following very different investment strategies. Each received $2,000 at the beginning of every year for the 20 years ending in 2006 and left the money in the market once invested. Check out how they fared:
The results are in: Investing immediately paid off
For the winner, look at the graph, which shows how much wealth each of the five investors had accumulated at the end of the 20 years (1987–2006). Actually, we looked at 62 separate 20-year periods in all, finding similar results across almost all time periods.
Naturally, the best results belonged to Peter, who waited and timed his annual investment perfectly: He accumulated $146,761. But the study’s most stunning findings concern Ashley, who came in second with $141,856—only $4,905 less than Peter Perfect. This relatively small difference is especially surprising considering that Ashley had simply put her money to work as soon as she received it each year—without any pretense of market timing.
Matthew’s dollar-cost-averaging approach delivered solid returns, earning him third place with $134,625 at the end of 20 years. That didn’t surprise us. After all, in a typical 12-month period, the market has risen 75% of the time.2 So Ashley’s pattern of investing first thing did, over time, yield lower buying prices than Matthew’s monthly discipline and, thus, higher ending wealth.
Rosie Rotten’s results also proved surprisingly encouraging. While her poor timing left her about $18,262 short of Ashley (who didn’t try timing investments), Rosie still earned significantly more than double what she would have if she hadn’t invested in the market at all.
And what of Larry Linger, the procrastinator who kept waiting for a better opportunity to buy stocks—and then didn’t buy at all? He fared worst of all, with only $61,622. His biggest worry had been investing at a market high. Ironically, had he done that each year, he would have still earned more than twice as much over the 20-year period.
[see also DCA or lump sum?]
Our research definitively shows that the cost of waiting for the perfect moment to invest far exceeds the benefit of even perfect timing. And because timing the market perfectly is, well, about as likely as winning the lottery, the best strategy for most of us mere mortal investors is not to try to market-time at all. Instead, make a plan and invest as soon as possible.
Five investing styles
But don’t take my word for it. Consider our research on the performance of five long-term investors following very different investment strategies. Each received $2,000 at the beginning of every year for the 20 years ending in 2006 and left the money in the market once invested. Check out how they fared:
- Peter Perfect was a perfect market timer. He had incredible skill (or luck) and was able to place his $2,000 into the market every year at the lowest monthly close.
For example, Peter had $2,000 to invest at the start of 1987. Rather than putting it immediately into the market, he waited and invested after month-end November 1987—that year’s monthly low point for the S&P 500® Index (a proxy for the stock market).
At the beginning of 1988, Peter received another $2,000. He waited and invested the money after January 1988, the monthly low point for the market for that year. He continued to time his investments perfectly every year through 2006. - Ashley Action took a simple, consistent approach: Each year, once she received her cash, she invested her $2,000 in the market at the earliest possible moment.
- Matthew Monthly divided his annual $2,000 allotment into 12 equal portions, which he invested at the beginning of each month. This strategy is known as dollar cost averaging. You may already be doing this through regular investments in your 401(k) plan or an Automatic Investment Plan (AIP), which allows you to deposit money into mutual funds on a set timetable.
- Rosie Rotten had incredibly poor timing—or perhaps terribly bad luck: She invested her $2,000 each year at the market’s peak, in stark defiance of the investing maxim to “buy low.” For example, Rosie invested her first $2,000 at the end of August 1987—that year’s monthly high point for the S&P 500. She received her second $2,000 at the beginning of 1988 and invested it at the end of December 1988, the peak for that year.
- Larry Linger left his money in cash (using Treasury bills as a proxy) every year and never got around to investing in stocks at all. He was always convinced that lower stock prices—and, therefore, better opportunities to invest his money—were just around the corner.
The results are in: Investing immediately paid off
For the winner, look at the graph, which shows how much wealth each of the five investors had accumulated at the end of the 20 years (1987–2006). Actually, we looked at 62 separate 20-year periods in all, finding similar results across almost all time periods.
Naturally, the best results belonged to Peter, who waited and timed his annual investment perfectly: He accumulated $146,761. But the study’s most stunning findings concern Ashley, who came in second with $141,856—only $4,905 less than Peter Perfect. This relatively small difference is especially surprising considering that Ashley had simply put her money to work as soon as she received it each year—without any pretense of market timing.
Matthew’s dollar-cost-averaging approach delivered solid returns, earning him third place with $134,625 at the end of 20 years. That didn’t surprise us. After all, in a typical 12-month period, the market has risen 75% of the time.2 So Ashley’s pattern of investing first thing did, over time, yield lower buying prices than Matthew’s monthly discipline and, thus, higher ending wealth.
Rosie Rotten’s results also proved surprisingly encouraging. While her poor timing left her about $18,262 short of Ashley (who didn’t try timing investments), Rosie still earned significantly more than double what she would have if she hadn’t invested in the market at all.
And what of Larry Linger, the procrastinator who kept waiting for a better opportunity to buy stocks—and then didn’t buy at all? He fared worst of all, with only $61,622. His biggest worry had been investing at a market high. Ironically, had he done that each year, he would have still earned more than twice as much over the 20-year period.
[see also DCA or lump sum?]
Tuesday, June 19, 2007
The Rich Get Richer
In 1976, Richard Freeman wrote a book called “The Overeducated American.” So many Americans had been getting college degrees that the relative wages of white-collar professionals had started to fall. It no longer paid to go to college and, for most of the ’70s, fewer people did. Just so, incomes of the educated began to rise again.
People like Freeman, a labor-market economist, waited for the cycle to turn. They expected that with white-collar types riding high again, more people would stay in school, and incomes at the top would level off once more.
But they never did. Instead, the rich kept getting richer. Across the spectrum of American society, the higher your income category, the more your income continued to grow. And for a quarter-century, albeit with zigs and zags along the way, that rich-get-richer pattern has held. The figures are striking. In 2004, according to the Congressional Budget Office’s latest official analysis, households in the lowest quintile of the country were making only 2 percent more (adjusted for inflation) than they were in 1979. Those in the next quintile managed only an 11 percent rise. And the middle group was up 15 percent. Do you sense a pattern? The income of families in the fourth quintile — upper-middle-class folks with an average yearly income of $82,000 — rose by 23 percent. Only when you get to the top quintile were the gains truly big — 63 percent.
Some redistribution is clearly good for the entire economy — providing public schooling, for instance, so that everyone gets an education. But public education aside, the United States has a pretty high tolerance for inequality. Americans care about “fairness” more than about “equalness.” We boo athletes suspected of taking steroids, but we admire billionaires.
The extreme divergence of American incomes we see today, however, is actually rather new. For most of the 20th century, America was becoming more egalitarian. The United States seemingly conformed to the standard theory of development, which held that industrialization produces fat cats at first (as factory owners rake it in) and then a more general prosperity as workers become more productive. It’s a feel-good theory that says, “Don’t worry if the rich are prospering; the poor will have their day.”
[via brknews, excerpted]
People like Freeman, a labor-market economist, waited for the cycle to turn. They expected that with white-collar types riding high again, more people would stay in school, and incomes at the top would level off once more.
But they never did. Instead, the rich kept getting richer. Across the spectrum of American society, the higher your income category, the more your income continued to grow. And for a quarter-century, albeit with zigs and zags along the way, that rich-get-richer pattern has held. The figures are striking. In 2004, according to the Congressional Budget Office’s latest official analysis, households in the lowest quintile of the country were making only 2 percent more (adjusted for inflation) than they were in 1979. Those in the next quintile managed only an 11 percent rise. And the middle group was up 15 percent. Do you sense a pattern? The income of families in the fourth quintile — upper-middle-class folks with an average yearly income of $82,000 — rose by 23 percent. Only when you get to the top quintile were the gains truly big — 63 percent.
Some redistribution is clearly good for the entire economy — providing public schooling, for instance, so that everyone gets an education. But public education aside, the United States has a pretty high tolerance for inequality. Americans care about “fairness” more than about “equalness.” We boo athletes suspected of taking steroids, but we admire billionaires.
The extreme divergence of American incomes we see today, however, is actually rather new. For most of the 20th century, America was becoming more egalitarian. The United States seemingly conformed to the standard theory of development, which held that industrialization produces fat cats at first (as factory owners rake it in) and then a more general prosperity as workers become more productive. It’s a feel-good theory that says, “Don’t worry if the rich are prospering; the poor will have their day.”
[via brknews, excerpted]
Wednesday, June 06, 2007
Traits of Extremely Wealthy People
Have you ever wondered why some people are magnets for wealth and most others just flounder by the wayside? I bet you want to know the secret traits these wealthy people possess.
Steve Jobs got rich creating and selling computers. J.K. Rowling is wealthy because she switched gears and started writing books. Jeff Bezos got rich selling books. Oprah Winfrey became wealthy connecting to people on TV. Wayne Huizenga became rich by hauling trash. Bill Gates started coding software and is a multi-billionaire.
Their businesses have nothing in common. Just look at your community. People are becoming wealthy in a variety of businesses.
What do Oprah, Jeff, Steve, Bill, Wayne, and J.K. have in common?
1. They have Persistence. Overcoming obstacles and moving on is a given.
2. They invest in other businesses and own their own companies. Start your own business.
3. They are creative. Innovation is imperative to becoming wealthy. Constantly observe and generate new ideas.
4. They are doing what comes most naturally to them. If you love what you do, you forget you are working. Imagine that.
5. They give their wealth back. Sharing wealth and knowledge benefits you and others. The more you give, the more you receive.
6. They are constantly learning. Enormously wealthy people understand that your mind is your greatest asset. They constantly read books, listen to wealth-building CDs and attend seminars.
7. They hire out the work. Rich people know they can’t do everything themselves. Bill Gates hires programmers to write software. Doing everything yourself will limit your financial growth opportunities.
8. They are grateful. With gratitude you can’t go wrong. In fact, gratitude allows your mind to focus on creating products that help and uplift other people’s lives.
Notice that all these traits use the power of the mind. Nothing compares to getting your mind to work for you. It’s a tool most people don’t use. Here is your opportunity to take a quantum leap into wealth consciousness.
“It is mathematically certain that you can succeed if you will find out the cause of success, and develop it to sufficient strength, and apply it properly to your work." – Wallace D. Wattles
Steve Jobs got rich creating and selling computers. J.K. Rowling is wealthy because she switched gears and started writing books. Jeff Bezos got rich selling books. Oprah Winfrey became wealthy connecting to people on TV. Wayne Huizenga became rich by hauling trash. Bill Gates started coding software and is a multi-billionaire.
Their businesses have nothing in common. Just look at your community. People are becoming wealthy in a variety of businesses.
What do Oprah, Jeff, Steve, Bill, Wayne, and J.K. have in common?
1. They have Persistence. Overcoming obstacles and moving on is a given.
2. They invest in other businesses and own their own companies. Start your own business.
3. They are creative. Innovation is imperative to becoming wealthy. Constantly observe and generate new ideas.
4. They are doing what comes most naturally to them. If you love what you do, you forget you are working. Imagine that.
5. They give their wealth back. Sharing wealth and knowledge benefits you and others. The more you give, the more you receive.
6. They are constantly learning. Enormously wealthy people understand that your mind is your greatest asset. They constantly read books, listen to wealth-building CDs and attend seminars.
7. They hire out the work. Rich people know they can’t do everything themselves. Bill Gates hires programmers to write software. Doing everything yourself will limit your financial growth opportunities.
8. They are grateful. With gratitude you can’t go wrong. In fact, gratitude allows your mind to focus on creating products that help and uplift other people’s lives.
Notice that all these traits use the power of the mind. Nothing compares to getting your mind to work for you. It’s a tool most people don’t use. Here is your opportunity to take a quantum leap into wealth consciousness.
“It is mathematically certain that you can succeed if you will find out the cause of success, and develop it to sufficient strength, and apply it properly to your work." – Wallace D. Wattles
blue chips not equal to diamonds
"Blue chip" stocks -- the stocks of large, established companies -- were long touted as great investments for "widows and orphans," who weren't expected to manage their money actively. And historically speaking, some blue chips have been great investments. Companies like General Electric (NYSE: GE) and Johnson & Johnson (NYSE: JNJ) have been rewarding shareholders with solid growth and strong dividends for decades. But as hedge fund manager Mohnish Pabrai points out in his recent book Mosaic: Perspectives on Investing, even blue chips don't last forever.
The average Fortune 500 company has a life expectancy of 40-50 years, and given that it can take 25 years or more for a new company to grow to Fortune 500 size, many so-called blue chips cease to exist less than 20 years after they make the list! Size is no guarantee of longevity -- just ask all those Enron shareholders. And even among more established firms, times and businesses change. I'm sure that most of the investors who bought Ford (NYSE: F) 15 or 20 years ago didn't foresee a time when the stock would be trading in single digits and the company desperately clinging to life.
The average Fortune 500 company has a life expectancy of 40-50 years, and given that it can take 25 years or more for a new company to grow to Fortune 500 size, many so-called blue chips cease to exist less than 20 years after they make the list! Size is no guarantee of longevity -- just ask all those Enron shareholders. And even among more established firms, times and businesses change. I'm sure that most of the investors who bought Ford (NYSE: F) 15 or 20 years ago didn't foresee a time when the stock would be trading in single digits and the company desperately clinging to life.