The study is titled: Value
vs. Glamour Revisited - Historical P/B Ratio Disparities and
Subsequent Value Stock Out-performance.
Where Glamour stocks are defined as
stocks with high price to book (“P/B”) values and Value stocks as
having low price to book ratios.
What makes this study remarkable is that they looked at
the difference in valuation between value and glamour stocks by
dividing the glamour stock P/B ratio by the value stock P/B ratio and
calculated the five year subsequent value out-performance against
glamour.
To visualise it more easily they looked
at the ratio: (Glamour P/B) / (Value P/B)
They found that after the ratio had
peaked, i.e. the valuation difference was largest, value stocks
delivered meaningful out-performance over the next 5 years.
The most extreme valuation difference
between glamour and value stocks occurred in February 2000 when
glamour stocks were 81.1 times more expensive than value stocks. In
the five year period from February 2000 value stocks
outperformed glamour stocks by 50.6% annualised. And that over five
years!
So, from the first study we know that
value outperforms glamour but the second study shows that when the
valuation difference gets larger the out-performance increases
substantially.
So what was the situation at the March 2009 market low point?
In February 2009 the valuation
difference climbed to 20.0, the last time it was this high was
January 2001. By April 30, 2009 the ration declined to 15.4 just
slightly above the 1968 to 2008 average of 12.3.
What does this mean for you and me?
First of all, buying undervalued
shares work as the first study has shown. And this using only one
simple ratio such as price to book, ignoring other important factors such as debt levels, return on assets and capital.
Secondly the worst time to
change your strategy is when the valuation differences are at their
greatest. As that is exactly the point when the greatest returns can
be made, if you stick to your strategy.
This is also exactly that a lot of
investors did not do during the internet bubble, value investors
changed their strategy, started buying technology shares, and lost
their shirts shortly thereafter.
Thus, if you have a strategy that you know works and that has been tested over long periods of time you have to keep on reminding yourself why you follow the strategy, so much so that you will not abandon the strategy when it has substantially underperformed the market and all may seem lost.
Because it is exactly from this point forward that you will make your largest gains.
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