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TWEEDY, BROWNE COMPANY L.P.
What Has Worked in Investing
(continued from preceding
page)
STOCKS THAT HAVE DECLINED IN PRICE
Stocks with the Worst Prior Investment Results
Werner F.M. DeBondt and Richard Thaler, Professors at the University of Wisconsin and Cornell University, respectively, examined the investment performance of stocks with the worst and best prior investment results in "Does the Stock Market Overreact?", Journal of Finance, July 1985.
DeBondt and Thaler selected on December 31, 1932, and on each December 31 thereafter through 1977, from all stocks listed on the New York Stock Exchange, a total of 46 separate experiments, the 35 worst performing and 35 best performing stocks over the preceding five years. For the worst performing stocks the average price decline was 45%. The investment results of the worst performing and best performing stocks were compared to a market index, the equal weighted investment results of all stocks listed on the New York Stock Exchange. The worst performing stocks over the preceding five-year period produced average cumulative returns of 18% in excess of the market index 17 months after portfolio formation, a compound annual return in excess of the market index of 12.2%. The best performing stocks over the preceding five years produced average cumulative returns of about 6% less than the market index after 17 months, a compounded annual negative return of 4.3% versus the market index.
DeBondt and Thaler also tested portfolios of worst and best performing stocks based on investment returns over the prior three years and found similar significant excess positive returns for the worst performing stocks and similar below market returns for the best performing stocks.
Stocks with the Worst Prior Investment Results Throughout the World
James M. Poterba and Lawrence H. Summers, Professors at Massachusetts Institute of Technology and Harvard University respectively examined in their study, "Mean Reversion in Stock Prices, Evidence and Implications." March 1988, whether investment results throughout the world tend to move toward an average return, with large increases in prices and returns followed by lower or negative returns and large declines in prices and returns followed by positive investment returns. The authors analyzed monthly New York Stock Exchange returns from 1926 through 1985, annual
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