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Value vs Growth. Value Stocks. Value: Low P/E Ratio Low MV/BV Ratio Low Price-to-Sales Ratio High Dividend Yield Price is “cheap” by some measure of comparison. Types of Value Investors. Passive Screeners
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Value Stocks Value: • Low P/E Ratio • Low MV/BV Ratio • Low Price-to-Sales Ratio • High Dividend Yield • Price is “cheap” by some measure of comparison
Types of Value Investors • Passive Screeners • Screen for stocks that have characteristics that you believe identify undervalued stocks • Contrarian Investors • Invest in companies that others have given up on • Activist Value Investors • Invest in poorly managed firms and then try to change the way the companies are run
Passive Screens P/E is less than the inverse of the yield on AAA Corporate Bonds P/E is less than 40% of average P/E over the last 5 years Price is less than 2/3 of Book Value Price is less than 2/3 of Net Current Assets D/E ratio is less than one
Passive Screens Current Assets are more than twice current liabilities Debt is less than twice net current assets Historical Growth in EPS over last ten years is greater than 7% No more than two years of negative earnings during the last ten years
Well-Known Value Screeners Benjamin Graham Warren Buffett (more activist in recent years)
Value Screen Results Empirical evidence indicates that over long time periods, low MV/BV stocks have outperformed high MV/BV stocks and the overall market both in the U.S. and internationally
Contrarian Value Investing • Contrarians believe that markets overreact to both good and bad news. So stocks that have had bad news are likely to be undervalued • Studies indicate that there is negative serial correlation in returns over long time periods • DeBondt and Thaler looked at 1933 - 1978
Contrarian Value Investing Some feel the findings overstate the potential returns on ‘loser’ portfolios as they are more likely to contain low-priced stocks which generate higher transactions costs and offer the potential for skewed returns Portfolios created in December work better than those created in June
Contrarian Value Investing • Good companies are not necessarily good investments • Current price may already reflect quality of management and firm • More potential for downside surprises than upside
Activist Value Investsing If value of firm is less than its component parts – push for breakup or spinoff If firm is too conservative in use of debt – push for higher leverage and recapitalization If firm is hording too much cash – push for higher dividends or stock repurchases
Activist Value Investing • If firm is being badly managed – push for a change in management or to be acquired • Example of Activist Value Investor • Carl Ichan
Growth Stocks • High P/E Ratio (high MV/BV) • Investor feels the value of the growth potential is being underestimated • Low PEG Ratio • Ratio of P/E to growth rate – PEG close to or below 1.0 is very good • But low PEG Ratio firms tend to be more risky • Earnings Momentum • Earnings growth over time
Activist Growth Investing • Venture Capital Funds • Help small, private start-up companies with their first infusion of capital. Usually take position on Board. Goal is usually to eventually do an IPO. • Leveraged Buyout Funds • Use significant debt to take over publicly traded firms and make them private • Private Equity Funds • Pool the wealth of individual investors to invest in private firms that show promise
Which Does Better?? • Over the long-run, value has outperformed growth, but growth tends to outperform value when the yield curve is flat or downward sloping. • Active growth investors seem to beat growth indices more often than active value investors beat value indices.
Small Cap Stocks Approximate Definitions: Big Cap: More than $10 billionMid Cap: $2 billion to $10 billion Small Cap: $300 million to $2 billion Micro Cap: $50 million to $300 million Nano Cap: Under $50 million
Small Cap Stocks • There is substantial empirical evidence that over time, small cap stocks have outperformed large cap stocks. • It may not be an excess risk-adjusted return though
Small Cap Stocks • The Small Stock Premium • Not very prevalent since 1981 • Mostly attributable to performance in 1970s when inflation was high • Almost entirely due to superior performance in the month of January
Risk and Size CAPM may not be the right model for risk of small stocks and thus beta doesn’t capture full measure of risk. Small stocks tend to be concentrated in just a few sectors Estimation risk of beta is higher for small firms (assuming beta is correct measure of risk) because there is less information available and fewer analysts cover them.
Size-Style Grid Funds are often classified by type: Lg Cap Value Lg Cap Growth Mid Cap Value Mid Cap Growth Sm Cap Value Sm Cap Growth
Size-Style Grid • The size-style grid can be used as a risk-adjustment model. • Abnormal Return = RP,t – R Benchmark,t where the “Benchmark” portfolio is an index matched on the Size and Value-Growth Dimensions.
