Which Value Investing Metrics Should You Trust?

Which Value Investing Metrics Should You Trust?

March 6, 2015 Value Investing Research, $vlue
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(Last Updated On: June 29, 2015)

Barry has a nice piece in the Washington Post asking a simple question:

What is the best valuation metric to assess if a stock is cheap or expensive?

Jack and I were honored to see that Barry highlighted our 2013 Journal of Portfolio Management paper:

Analyzing Valuation Measures: A Performance Horse Race over the Past 40 Years

You can download an old version of the paper here and there is a in-depth summary at the following link.

The chart below presents the key table from our paper:

Which Value Investing Metrics Should You Trust
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Barry’s comment on our paper:

Perhaps the most readable of these is from Wesley Gray and Jack Vogel: “Analyzing Valuation Measures: A Performance Horse-Race Over the Past 40 Years” (Drexel University, January 2012).

These papers (and others) have identified a ratio that has been described as the single most successful measure of valuation in terms of historical track record: EV/EBITDA.

Barry also highlights another great paper on the subject from Tim Loughran and Jay Wellman.

A close second is Tim Loughran and Jay W. Wellman’s “New Evidence on the Relation Between the Enterprise Multiple and Average Stock Returns.”

We did a deeper dive on this paper in the following blog post.

Here is my favorite chart from the paper:

ebit multiple results
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

 

Conclusion

Buying cheap stocks has been a good strategy–at least historically. And it certainly seems that enterprise multiples are more effective, on average, than measures that are more commonly used (e.g., book-to-market, or price-to-earnings).

Who knows which metric will be the best in the future, but one lesson is clear: buy cheap stocks. And if you don’t have the stomach of patience do buy individual stocks, identify value investing funds, value investing etfs, or value-focused stock-pickers searching in the bargain bin of the marketplace.

 


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Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  • dph

    Are there any good publically traded funds/etfs that use the EBIDTA/TEV multiple as a dominant screening criteria?

  • Jack Vogel, PhD

    Can’t comment on funds specifically, but we run investment advisory strategies using EBIT/TEV, located here: http://www.alphaarchitect.com/advisory

  • dph

    I see. Also I’d presume your ETFs use similar strategies.