Dirt Cheap Stocks Are Too Risky

Dirt Cheap Stocks Are Too Risky

Dirt Cheap Stocks By Become A Better Investor

At A. Stotz Investment Research we look at investing through our FVMR framework: Fundamentals, Valuation, Momentum, and Risk. To come up with investment strategies for portfolios that should generate above-benchmark return we do a lot of backtesting. Below you can see a few factors that we consider when we look at the valuation of a company.

Testing if #investing in companies with low Price-to-Book generates outperformance

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We previously tested a Fundamentals factor, return on assets in Investing Is Not Just Buying Highly Profitable Companies. In this post, we will put price-to-book to test.


Investing in cheap companies with low price-to-book (PB) generates outperformance.

Dirt Cheap Stocks – Universe


When backtesting, you should use original statements (and not re-stated) to avoid hindsight bias. When you backtest you also need to know and adjust for when a company closes its books. A company may close its books in December but that data is only available some months after on the announcement date. Focus on the announcement date when you backtest.

This was our process to come up with a global universe to test our hypothesis: 

  • Started with all companies listed anywhere in the world with a market capitalization of more than or equal to US$40m, which left us with 26,564 companies
  • Applied a US$50m minimum market capitalization screen, which left us with 25,039 companies
  • Filtered out illiquid stocks with a three-month average daily turnover of less than US$250,000 and was left with 16,270 stocks
  • Excluded stocks of financial companies
  • Excluded companies that did not close their books in December
  • We removed 6,439 stocks (40%), leaving 9,831


How to calculate Price-to-Book Value

  • On the last day of March of each year we ranked all stocks from lowest PB to highest
  • Divided that list up into deciles
  • Measured the share price performance of each decile over the coming 12 months
  • Re-ranked after 12 months and reallocated the money of each decile into the new stocks included in each decile
  • Repeated for 10 years


Investing in cheap stocks with low price-to-book only seems to work when they’re dirt cheap. The return of the decile with the lowest PB stocks had the highest return both for equal-weighted and market cap-weighted. With exception for this decile there is no clear relationship.

Dirt Cheap Stocks Investing in low price-to-book only works when the stocks are dirt cheap

Dirt Cheap Stocks


Investing in low PB only doesn’t work. When we have adjusted for risk, it no longer works, not even for the dirt cheap stocks.

Dirt Cheap Stocks Looking at risk-adjusted return, buying low price-to-book doesn't work

Dirt Cheap Stocks


For market cap-weighted there is no clear relationship and for equal-weighted it actually looks like expensive stocks with high PB generates higher risk-adjusted return.


Our hypothesis turned out to be wrong, we can’t support that investing in low PB stocks generates higher future returns. Investing based on PB alone doesn’t seem to work.

It’s not uncommon when backtesting that you find that a factor doesn’t work. However, you shouldn’t give up. Some factors only work in certain markets and many times you neeed to find a combination of factors that work.

Going forward we’ll test Momentum and Risk factors, stay tuned.


Is this the results you expected from price-to-book?

Let us know your thoughts in a comment below.


DISCLAIMER: This content is for information purposes only. It is not intended to be investment advice. Readers should not consider statements made by the author(s) as formal recommendations and should consult their financial advisor before making any investment decisions. While the information provided is believed to be accurate, it may include errors or inaccuracies. The author(s) cannot be held liable for any actions taken as a result of reading this article.


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Dr. Andrew Stotz, CFA is the CEO of A. Stotz Investment Research, a company providing institutional investors with ready-to- invest portfolios in Asia that aim to beat the benchmark through superior stock selection. The company also provides buy- and sell-side clients with financial models to value any company in the world and World Class Benchmarking to determine what companies are financially world class. Previously, as Head of Research at CLSA, Andrew was voted No. 1 Analyst in Thailand in the Asiamoney Brokers Polls for 2008 and 2009. He was also voted No. 1 Analyst in Thailand in the 2009 Institutional Investor magazine All-Asia Research Team Report. Andrew earned his PhD in finance at the University of Science and Technology of China in Anhui province, with a focus on answering questions raised by fund managers and analysts during his career about picking stocks and managing portfolios. In addition, Andrew has been a lecturer in finance for 22 years at various universities in Thailand. Since 2013, he has been the president of the CFA Society of Thailand. He is also the author of How to Start Building Your Wealth Investing in the Stock Market.

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