Saturday, September 6, 2008

Value Investing Today: Chp 3: The Value Pedigree and the Rewards of Value Investing

Brandes references the value investing research by Fama and French which shows value stocks outperforming growth stocks over a 40 year time period. The lower price-to-book stocks that made up the value stocks also had less risk as measured by volatility of returns than the growth stocks.

Another study by Lakonishok, Shleifer and Vishny (LSV) shows that growth stocks do not actually grow faster than value stocks. In this study, the cash flow of growth stocks was expected to grow 11.3% faster than value stocks but actually grew .4% slower. This study conducted over the time period of 1968 to 1994 also showed that value stocks dramatically outperformed growth stocks.

Brandes also presents the value investing manager track records of Buffet, Ruane and Neff over the time period 1973 - 2002 (representing Berkshire Hathaway, Sequoia Fund and the Vanguard Windsor fund respectively). Each of these value investors have shown returns in excess of the S&P 500 over the given time period. It is interesting to note that these three investors underperformed the market around 25% of the time, but their overall results are significantly higher than the market. Buffet, Ruane and Neff achieved returns of 25.5%, 16.9% and 12.9% respectively in their portfolios versus the 10.6% return for the S&P 500 over the 1973 - 2002 time period.

Brandes feels that value investing is likely to continue working because of the prominence of professional investors and the short time frames used in benchmarking these professionals. Most professional investors are benchmarked against a market index and their overall compensation often depends on beating this benchmark at yearly or even at quarterly intervals. Professional money managers would not likely be able to wait the 3-5 years it could take for value investing principles to pay off for them. In addition, many clients are not patient enough to allow a longer time frame strategy like value investing to work.

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