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TWEEDY, BROWNE COMPANY L.P.
What Has Worked in Investing
(continued from preceding
page)
Most studies which examined the relationship between investment returns and investment characteristics such as price to book value, price to earnings, price to cash flow, dividend yield, market capitalization, insider purchases, or company share repurchases have compared the relationship between only one investment characteristic and subsequent returns. Occasionally, two investment characteristics, such as price to book value and market capitalization, or price to earnings and market capitalization have been examined in relation to returns.
In more than one study we noted that investments screened for one of the characteristics had several of the others which corresponded to Tweedy, Browne's own investment experience. Companies selling at low prices in relation to net current assets book value and/or earnings often have many of the other characteristics associated with excess return. Current earnings are often depressed in relation to prior levels of earnings especially for companies priced below book value. The price is frequently low relative to cash flow, and the dividend yield is often high. More often than not the stock price has declined significantly from prior levels. The market capitalization of the company is generally small. Corporate officers, directors and other insiders have often been accumulating the company's stock. The company itself has frequently been repurchasing its shares in the open market. Furthermore, these companies are often priced in the stock market at substantial discounts to real world estimates of the value that shareholders would receive in a sale or liquidation of the entire company. Each characteristic seems somewhat analogous to one piece of a mosaic. When several of the pieces are arranged together, the picture can be clearly seen: an undervalued stock.
In all of the preceding studies, there was a correlation between the investment criterion or characteristic and excess return. In most of the studies, the return information presented was a single average annual percentage return figure which summarized the investment results over a very long measurement period (54 years in the case of Rolf Banz's study of small capitalization stocks). This summary average annual return figure encompassed and was mathematically determined by, the separate investment returns of the many smaller periods of time which comprised the entire length of time of each study. The studies, with one exception, did not present information or conclusions concerning the pattern sequence or consistency of investment returns over the shorter subset periods of time which comprised the entire measurement period. Questions such as whether the excess returns were generated in 50% of the years or 30% of the years or in a seven year "run" of outperformance followed by seven "dry years" of underperformance, or whether the excess returns were produced primarily in advancing or declining stock markets were only addressed in one study, Contrarian Investment, Extrapolation and Risk, by Professors Lakonishok, Vishny and Shleifer. Their study over the 1968 through 1990 period, indicated fairly consistent results over 1-year holding periods and increasingly consistent results over 3-year and 5-year holding periods for low price to book value and low price to cash flow stocks, as their performance edge accumulated with the passage of time. This performance edge was attained through outperformance
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