The world of investing can be a daunting place for beginners and even the more experienced investor. It can take decades to find your investment feet, test different strategies and to develop a money management style that suits both you and your lifestyle.
It is important that while you are developing your own strategy to avoid being drawn into other strategies, which claim to have better and more sustainable returns. But how do you know which ones to avoid and which ones to take a second look at?
Tweedy Browne Company LLC has produced a booklet that may answer this key question.
Titled, "What Has Worked In Investing," the booklet looks at some studies of investment approaches and characteristics associated with exceptional returns to help the average investor sort the good from the bad and choose the best strategy for their investment goals.
“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…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…A knowledge of the recurring and often interrelated patterns of investment success over long periods has not only enhanced our investment process, but has also provided long-term perspective and, occasionally, patience and perseverance. We hope this knowledge will also serve you well.” – Introduction Tweedy, Browne’s What Has Worked in Investing
I have not got room to go through all the 50 studies contained in the booklet here, but below are a few of the studies which I find are the most informative for investors of all styles and experiences.
What Has Worked In Investing: Charts
The two fundamental cornerstones of value investing are buying stocks at a discount book value or below intrinsic value and holding for the long-term until the value is realized.
Tweedy, Browne's booklet displays the benefit of this strategy, with a study by Josef Lakonishok, Robert W. Vishny and Andrei Shleifer, who looked at the effect of price as a percentage of book value on investment returns in “Contrarian Investment, Extrapolation and Risk,” Working Paper No. 4360, National Bureau of Economic Research, May 1993. For the study, the professors ranked all companies listed on the NYSE and the AMEX according to the stock price as a percentage of book value and sorted the companies into deciles. The study began in 1968 and ended in 1990. The portfolios were held for five years. The results of the study are shown below.
The second study that I believe is the most informative for investors comes from Credit Suisse. In this study, Credit Suisse analysts Pankaj N. Patel, Souheang Yao and Heath Barefoot tried to prove that while dividend stocks to achieve the best returns for investors on a total return basis, the highest yielding stocks should be avoided as they are not overall leaders regarding total return. The study run a simulation of a dividend strategy from January 1980 to June 2006. The analysts created equal weighted decile baskets, based on dividend yield at the end of each month and only stocks within the S&P 500 were included. Over the study period, they found that high dividend stocks outperformed those with low yields, but the highest yielding stocks lagged behind those with more moderate income streams, as shown in the table below.
Further analysis by Pankaj Patel and Souheang Yao revealed that stocks with the highest yields combined with the lowest payout ratios produce the best returns. By separating the stocks included in the above study into 'payout ratio buckets.' analysis shows that equities with a high yield but low payout ratio generated an annualized return for the period studied of 19.2% versus 11.2% the S&P 500. Those companies with a high payout ratio actually underperformed both the S&P 500 and companies that offered no dividend income.
The third and final study I want to include in this article is a collection of figures from a number of studies over several years. These studies look at the impact of insider accumulation, a topic that has been examined numerous times by academics. Tweedy, Browne gathers the figures from five different studies to produce one table, which details the investment returns on stocks purchased after insiders' purchases over the period 1958 to 1976. All of the studies assumed that investments were made in the shares of companies which had more than one side of purchase shares and the number of shares purchased had significantly exceeded the number of insider sales during the same period. Returns were calculated in the period after the insider acquisition became public knowledge. As you can see from the table below, following insiders into positions would have been a very lucrative strategy indeed.
The studies that make up the table are:
- Donald T. Rogoff, “The Forecasting Properties of Insider Transactions,” Diss., Michigan State University, 1964;
- Gary S. Glass, “Extensive Insider Accumulation as an Indicator of Near Term Stock Price Performance,” Diss., Ohio State University, 1966;
- Charles W. Devere, Jr., “Relationship Between Insider Trading and Future Performance of NYSE Common Stocks 1960 - 1965,” Diss., Portland State College, 1968;
- Jeffrey F.Jaffe, “Special Information and Insider Trading,” Journal of Business, July 1974; and
- Martin E. Zweig, “Canny Insiders: Their Transactions Give a Clue to Market Performance,” Barron’s, July 21, 1976.
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