VALUE VS. GROWTH: GUESS WHICH STOCKS ARE THE WINNERS
For at least 60 years, so-called value investors have advocated buying stocks that have low prices relative to current earnings, cash flow, or other measures of intrinsic value. Growth investors, on the other hand, have pushed glamour stocks with high price-earnings ratios as a way to capitalize on the growth potential of successful companies that have won market approval.
A recent National Bureau of Economic Research study by Josef Lakonishok, Andrei Shleifer, and Robert W. Vishny weighs the evidence in copious detail. And its conclusion, based on an analysis of the performance of all stocks listed on the New York and American Stock Exchanges from 1968 to 1990 is that the value strategy wins hands down.
The researchers compared the performance of the 10% of stocks with lowest prices relative to earnings, cash flow, dividends, or book value in each year from 1968 to 1985 with the 10% of stocks in that year with the highest price multiple relative to the same variables. They found that no matter what year they chose or what variable they looked at, the lower-priced value stocks outperformed the high-flying glamour stocks over the subsequent five-year period (though not in every single year) by a significant margin.
Net returns averaged 7.8% a year higher in the case of price-to-book-value ratios and 8.8% a year higher in the case of price-cash-flow ratios. In other words, investing in the 10% of stocks with the lowest multiples in any year would have produced five-year cumulative returns 38% to 43% larger than those produced by investing in the 10% of stocks with the highest multiples.
The researchers also reject the argument that low-multiple stocks outperform glamour stocks because they're riskier. Although value stocks are a bit more volatile than glamour stocks, they found that the volatility was concentrated on the upside. In other words, value stocks tend to fall less than growth stocks (and stocks overall) in bear markets and rise more in bull markets.
The mystery, of course, is why investors haven't shifted more toward value stocks (and thus reduced the large differential in stock returns). One possibility is that institutional traders have very short time horizons. Another may be that investors are more interested in individual companies than in statistical investment formulas, and glamour stocks have a good story to tell. Whatever the reason, however, value investing has had a remarkably consistent track record.GENE KORETZ