May

26

 The problem I have had with the former advertising manager's methodology is that it is not clear to me that any studies show that value outperforms growth, and I am not convinced he used prospective files for his studies, even though the rumor is that the Columbia students he hired to do his research did so, and the results in his books are completely random, as well as the wide diffusion of his seemingly random and regime based studies.

Allen Gillespie writes:

The misapplication comes by using P/B to declare stocks growth or value. The best growth stocks have little in way of book but much (non-book) goodwill (though not always booked goodwill) associated with the product or brand. In fact, some of the best growth stocks show this interesting pattern (high sales and earnings growth) while the value competitor shows on Altman Z-Score screens (think SNDK/EK, NFLX/BBI). One grows by eating the other (monopoly rents) and rebirth. How many stores did Walmart eat? If one looks at the pure style indices (RPG and RPV etfs) v. the old Russell two way classification (IWF and IWD) one will find the excess returns above cash for the growth and value risk premiums are equal and greater than the traditional growth and value classification (where there is a value bias). This makes sense, as the pure style indices are more concentrated into those stocks that actually exhibit the growth/value factors. Particularly regarding growth, imagine the age distribution of a population, it will have more adults than children because more are grown than growing. If you sliced it in half you will have one set with some growth, but highly diluted. This also presents an index problem as by definition young companies are likely not to be included in the indices initially and will be underweighted even when they are. None of this, of course, is to deny that there aren't cycles where the relative spreads between the combinations don't over or under shoot the trend.

Industries, of course, can regenerate by cannabilizing themselves at times (I am watching closely) the combination of high fuel prices and cars– the fuel efficient fleet will ultimately eat the existing stock leading to a long number of years of above average growth into a downsized industry. This is the value players dream situation as the stocks will be priced on the history with the future ahead. 100 years ago horsepower add horses, even on the tracks unfortunately.

Rocky Humbert writes:

(With SAT test season approaching, I humbly request that fellow specs weigh-in with the current usage in my paragraph 2 below. Should the correct form of to-be be "is" or "are"? [….a portfolio of stocks which *is* trading…] If we cannot reach consensus on the proper rules of English usage, there's no hope for other conciliations.) 

A problem with the problem is the definition of "value" versus "growth." S&P's methodology is to put stocks with low p-e's (or p/b's) into the value category, and stocks with high p-e's into the growth category. The approach is self-referential, and although convenient, it's arbitrary and silly.

Yet, if one takes the S&P approach ad absurdem, The Chair cannot quarrel with the proposition that a portfolio of financially strong stocks which is trading at 5x earnings (and which is paying out 100% of earnings as dividends) will eventually outperform a portfolio of stocks which are trading at 1,0000000000x earnings. The asymptotic nature of compounding and the laws of economics ensure that this will be eventually true. Once The Chair accepts the irrefutable truth of this observation, the discussion becomes much more nuanced — leading to an analysis of what conditions lead to Value outperforming Growth or visa versa.

Lastly, one must note that, in general, the volatility of stock prices is greater than the volatility of the underlying business performance. This is the essence of "taking out the canes" — and one wonders whether value investing is a second cousin of Mr. Clewes?

Tim Melvin writes:

Let's use Walter Schloss's definition and see if any testers with better databases and math skills than I can compute the results.

True value investing as practiced by Graham, Schloss, Kahn, Whitman et al looks something like this:

price below tangible book value

debt to equity ration below .3

profitable or at least breakeven

closer to lows for the year than highs

a minimum of 10% insider ownership

Using pe or relative value is NOT value investing as best and originally define.


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