Index Investor Corner

Swedroe: The Best Approach To ‘Value’

January 06, 2014
Share:

Sifting through the variety of ways to access value stocks.

It’s well documented in the academic research on stock returns that value stocks have outperformed growth stocks. And we see the higher returns to value stocks in almost all countries. And not only has value outperformed growth, but the persistence of its outperformance has been greater than the persistence of stocks outperforming bonds.

When implementing a value strategy, many different metrics can be used. Among the most common are price-to-earnings, price-to-sales, price-to-book value, price-to-dividends and price-to-cash flow. All the various approaches produce results showing that value stocks have had higher returns than growth stocks. And the various measures produce similar results, with the weakest results coming from the use of the dividend-to-price ratio.

Given the similarity in results, the price-to-book ratio has been used the most because book value is more stable over time than the other metrics. That helps keep portfolio turnover down, which in turn keeps trading costs down and tax efficiency higher.

Recently, some passively managed funds have moved away from the single-screen metric, as their research indicates that using multiple screens produces better results. Bridgeway and Vericimetry are two examples of fund families that have adopted this approach. In addition, the funds based on the RAFI indexes also use multiple screens (sales, earnings, dividends and book value).

In other words, the search for the best metric to use when implementing a value strategy continues.

To help us out, let’s look at what the authors of the 2012 study “Analyzing Valuation Measures: A Performance Horse-Race Over the Past 40 Years,” found. They covered the 40-year period 1971-2010 examined the returns to a variety of value metrics:

  • Earnings to Market Capitalization (E/M)
  • Earnings before interest and taxes and depreciation and amortization to total enterprise value (EBITDA/TEV). (Total enterprise value is defined as market capitalization + short-term debt + long-term debt + preferred stock value – cash and short-term investments.)
  • Free cash flow to total enterprise value (FCF/TEV)
  • Gross profits to total enterprise value (GP/TEV)
  • Book to market (B/M)
  • Forward earnings estimates to market capitalization (FE/M)

Following is a brief summary of their findings:

 

 

ETF.COM CHANNELS

Learn why commodity ETFs are an essential part of a diversified portfolio with our Commodity ETFs channel.

Learn why bond ETFs are an essential part of a diversified portfolio with our bond ETF channel.

ETF DAILY DATA

The biotech ETF was the biggest loser in terms of outflows on Friday, Feb. 5.

Vanguard ETF assets ticked up on Friday, Feb. 5.

ETF.COM ANALYST BLOGS

By Dave Nadig

For all the hype, here’s an example of an ETF working just as it should.

By Matt Hougan

Here's why you should attend the largest ETF conference in the world next month.

By Dave Nadig

Barclays built in a premium to this exchange-traded note, so back away.

By Sumit Roy

Why this probably isn't the start of a bear market.

ETF INDUSTRY PERSPECTIVE

By Heidi Richardson

Opportunities in Germany and the eurozone.

By Shirish Malekar

How to protect your portfolio with liquid alts.