Timeless Reading – Part Two: What Has Worked In Investing

What has worked in investing?

This is part two of a ten-part series on some of the most important and educational literature for investors with a focus on value. Across this ten-part series, I’m going to take a look at ten academic studies and research papers from some of the world’s most prominent value investors and fund managers.

All of the material can be found under the ‘Timeless Reading’ tab on the menu bar at the top of this page. And if you don’t know where to start, we’ve put together a ‘Value Investors Must Read List’ of resources, which once again can be found under the Timeless Reading tab. Part one of this series can be found at the link below.

1. Timeless Reading — Part I — Warren Buffett On Gold

Timeless reading — Part two: What has worked in investing

Part two of this series is devoted to a research booklet published by Tweedy, Browne Company LLC. Tweedy, Browne has become synonymous with value investing over the years. Founded in 1920, Benjamin Graham was one of the firm’s primary brokerage clients in the 1930s, 1940s, and 1950s. Then during 1959 the partners of Tweedy, Browne and Tom Knapp (who had joined from the Graham-Newman) pooled their capital in a partnership investment vehicle. You can read more about  Tom Knapp at ValueWalk’s exclusive Tom Knapp Resource Page.

Tweedy, Browne’s booklet, “What Has Worked In Investing” groups together several studies of investment approaches and characteristics associated with exceptional returns. The booklet begins:

“Dear Investor:

What Has Worked in Investing is an attempt to share with you our knowledge of historically successful investment characteristics and approaches. Included in this booklet are descriptions of over 50 studies, approximately half of which relate to non-U.S. stocks. Our choice of studies has not been selective; we merely included most of the major studies we have seen through the years. Interestingly, geography had no influence on the basic conclusion that stocks possessing the characteristics described in this booklet provided the best returns over long periods of time. While this conclusion comes as no surprise to us, it does provide empirical evidence that Benjamin Graham’s principles of investing, first described in 1934 in his book, Security Analysis, continue to serve investors well.”

But with over 50 studies to cover, published across 60 page, I can only scratch the surface of the data gathered together within “What Has Worked In Investing”. So, to try and condense as much information into this one article as possible, I’m going to look at one random study from each of the study groups in the booklet. Studies of returns generated through different strategies are grouped into six categories:

1. Assets bought cheap
2. Earnings bought cheap
3. Stocks with high dividend yields
4. Investing with the inner circle: buying stocks where the insiders (officers, directors or the company itself) are buying
5. Stocks that have declined in price
6. Stocks with smaller market capitalizations.

What has worked in investing: Assets bought cheap

The most famous “Assets bought cheap” strategy is Benjamin Graham’s “Net Current Asset Value Stock Selection Criterion”.

Another study, “Are Low Price-to-Book Value Stocks’ Higher Returns, as Compared to High Price-to Book Value Stocks, due to Higher Risk?” attempted to assess the riskiness of using a deep value. Professors Lakonishok, Vishny and Shleifer measured monthly investment returns in relation to price as a percentage of book value between April 30, 1968 and April 30, 1990. They found that the low price-to-book value stocks outperformed the high price-to-book value stocks in the market’s worst 25 months, and in the other 88 months when the market declined. And concluded:

“Overall, the value strategy [low price-to-book value] appears to do somewhat better than the glamor strategy [high price-to-book value] in all states and significantly better in some states. If anything, the superior performance of the value strategy is skewed toward negative return months rather than positive return months. The evidence [in Table 9] thus shows that the value strategy does not expose investors to greater downside risk.”

What has worked in investing: Low price to book value

What has worked in investing  - Earnings bought cheap

One of the most interesting studies in the “Earnings bought cheap” section of the booklet is “The Performance of Value Portfolios Versus Growth Portfolios Revisited through 2001”. An article titled “Value and Growth Investing: Review and Update,” published within the  Financial Analysts Journal, Vol. 60, No. 1, pp. 71-86, January/February 2004 Louis K.C. Chan and Josef Lakonishok reviewed the performance of growth and value strategies through 2001. They found that even after taking into account the experience of the technology led stock markets of the late 1990s, value stocks generated superior returns. They further concluded that common measures of risk do not support the argument that the return differential is a result of the higher riskiness of value stocks, but rather, in their opinion, is due to behavioral considerations and the agency costs of delegated investment management.

What has worked