A portfolio strategy that select stocks with strong value characteristics, e.g. book to market ratio, has on average outperformed overall market and growth stocks. For example, one dollar invested in large value stocks in 1965 was worth 177 dollars at the end of 2005. A similar investment in the overall market would be worth only 57 dollars. The one dollar investment in small value stocks was worth 919 dollars! This site will briefly summarize the findings in academic papers about value oriented stock selection methods from the past two decades. The papers will review the success of the value strategies in the US data in small and large stocks and international stock data as well. The information provided here is meant to provide an entry point to the empirical value studies past and present.
These are the first studies analyzing value portfolio strategies that have more than 10 years of data and received the most attention.
Early Studies: One-Dimensional Description of Value
- Basu, “Investment Performance of Common Stocks in Relation to their Price-Earnings Ratios: A Test of the Efficient Market Hypothesis”, 1977
- Rosenberg, Reid, Lanstein, “Persuasive Evidence of Market Inefficiency”, 1985
Second Generation: Multi-Dimensional Description of Value
- Fama & French, “The Cross-Section of Expected Stock Returns”, 1992
- Basu, “Earnings’ Yield and the Size Effect”, 1983
- Lakonishok, Shleifer, Vishny (LSV), “Contrarian Investment, Extrapolation, and Risk”, 1994
Fama & French 3 Factor Model Successes
- 1993, High Minus Low (HML) factor
- 1995, Multi-factor success with LSV portfolios
Author: Basu S.
Title: Investment Performance of Common Stocks in Relation to their Price-Earnings Ratios: A Test of the Efficient Market Hypothesis
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Publish Date: 6/1977 in Journal of Finance
Sample: NYSE 9/1956-8/1971
Keyword: P/E ratio
Basu looks at the relationship between common stocks and their price-earnings (P/E) ratio and finds out that the low P/E ratio portfolio earned six percent more per year than a high P/E portfolio in the 14 year sample. Basu is was not the first to investigate price-earnings relationships or the inverse statistic, earnings yield, but the articles that precede Basu have a much smaller time-series , hence making the statistical strength less reliable. The stocks are ranked according to their E/P ratio and divided into five equally weighted portfolios and re-ranked in January and rebalanced annually in April. The stocks are traded on the NYSE Euronext (NYSE:NYX), compiled in the COMPUSTAT database and must have at least 60 months of data before being included in one of the five portfolios which contain around 100 securities. The low P/E high return relationship strictly increases from quintiles two to five. The highest earnings yield quintile earned 16.30% on average per year compared to 9.34% by the lowest quintile, and a 4.3% return on T-Bills.
E/P avoids any pathological P/E ratio where the earnings are close to zero or negative.
The portfolios are rebalanced in April to ensure the information was available to investors.
Author: Rosenberg B., Reid K., Lanstein, R.
Title: Persuasive Evidence of Market Inefficiency
Publish Date: Spring 1985, Journal of Portfolio Management
Sample: 1/1973-9/1984 NYSE/Large Cap Stocks
Keyword: B/M ratio
Rosenberg, Reid, and Lanstein (RRL) is generally the first cited study that evaluates the performance of the book to market (B/M) strategy. They create a monthly hedge portfolio based upon data available at the prior month’s close from 1400 securities in the “HICAP” universe. The hedge portfolio has equal long and short positions and attempts to control for a number of factors such as size, E/P, share turnover, and industry classification. Their hedge portfolio, long high B/M stocks and short B/M stocks, had an average monthly return of 0.36% during the 12 year time span of their study and was positive 38 of the 54 months. There is a strong seasonality in the returns where the average January return is 1.7% and a downward trend from the early months to the late months which is also documented by Fama and French (See Risk Factors in the Returns on Stocks and Bonds).