"Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well. "
Warren Buffett
Studies have shown again and again that investing in stocks with the lowest valuations, such as P/E or P/B, will beat market cap weighted indices and give investors higher than average returns over the long run.
'What works on Wall Street' by James O'Shaughnessy is the best book I have read on the topic and analyses a multitude of different valuation metrics, the best at this point of time being EV/EBITDA but most of them work well.
Here is a video clip I saw recently of the author that describes the philosophy a bit more of avoiding glamour, highly valued stocks and investing in stocks with the best valuations.
(On a side note interestingly Apple currently falls into the low value composite group, despite getting close to new highs again, as well as Berkshire Hathaway purchases DirecTV and IBM.......)
As readers of the book may be familiar with, one of the best performing valuation methodologies is to score stocks on several valuation metrics and invest in those with the best value composite. In this video he mentions P/E, P/S, EV/EBITDA, EV/FCF and shareholder yield.
Greenbackd on his blog has combined the relatively simple P/E, P/B and P/FCF and looked at its performance from 1951 to 2013 in the US stock market, investing in the decile of stocks with the lowest overall score. A juicy CAGR 20.5% is obtained by this simple quantitative methodology.
Interestingly the real benefit over the single metrics is not necessarily the overall performance (which all beat S&P500) but the smoothing out of relative performance. Low valuation investing doesn't win year in-year out and outperformance comes and goes so it's not possible to know ahead of time which will outperform in the coming years. One way to avoid this problem is to combine them and pick stocks that have low valuations across several ratios.
Below is a list of the 5 currently 'best valued' stocks in the Swedish stock market. I've scored them using several valuation ratios, P/E, P/S, P/B and Dividend Yield, to create a composite valuation.
Below is a list of 5 'glamour' stocks, companies with high valuations, great stories, lots of potential and promises of growth in the future. The difficulty here is predicting how much growth there will be and how much should investors pay for it now. Unfortunately, history tell us that the tendency is too pay too much.
The fascinating part of these type of investing strategies is how simple they are, yet the data tells us that private investors struggle to even match the returns of indices. Perhaps it's too boring to simply create a shopping list once a year based P/E ratios, investors want to hear a story and compelling reasons why the stock is undervalued or why it will grow in the future.
Yet the data is clear, invest in stocks with low valuations, ride out the ups and downs and you will be suitably rewarded.
