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Value Investing

A Time-Tested Investing Strategy

By Elliott H. Gue, on Sep. 3, 2013

On Aug. 23, 2013, the S&P 500 hit an all-time high of 1709.67. This record is less impressive when you consider America’s most widely watched equity index first traded within 10 percent of that high more than 13 years ago on March 23, 2000.

For this reason, some pundits have labeled the 2000s the US stock market’s lost decade. Consider that from the end of 1999 to the end of 2009, the S&P 500 shed a little more than 9 percent of its value, equivalent to an average annual loss of 1 percent. Over the 13 years ended July 31, 2013, the S&P 500 generated an average annual return of 3.23 percent–barely enough to keep pace with inflation.

But one of the oldest, least complex investment strategies has worked wonders over the past 13 years, returning an average annual gain of 17.1 percent. This approach involved no market timing or committing large sums of capital to volatile stocks. In fact, you didn’t even need to select stocks outside the S&P 500.

Many consider Benjamin Graham to be among the greatest investors in history.  They’re in good company: The legendary Warren Buffet once described Graham’s 1949 book, The Intelligent Investor, as “by far the best book about investing ever written.” Buffett studied under Graham and has stated that his former teacher had more influence on him than any other man, save his father.

Graham’s basic strategy involved carefully assessing a company’s fundamentals and buying only those businesses that could be purchased at a discount to their intrinsic value–a proposition that’s complex in its simplicity. Graham, Buffett and many other successful value investors have different definitions of how to evaluate a company.

But some of the easiest screens for potential value plays involve the use of ratios such as price to earnings (P/E), price to book (P/B) and price to sales (P/S). Stocks with high valuation ratios tend to be market darlings; their P/E and P/S ratios are elevated because investors anticipate superior revenue and earnings growth. These sky-high expectations can prove tough to meet or exceed over the long term.

In contrast, expectations for companies with low P/E, P/S and P/B ratios aren’t demanding; these out-of-favor names are the place to look for strong value candidates.

Some of the simplest value-investing strategies have a long history of beating the broader market, including during the lackluster investing environment of the past 13 years. 

Consider the performance of four different investment strategies from July 31, 2000, to July 31, 2013. The first invested in the S&P 500 SPDR (NYSE: SPY), the second in the 10 percent of S&P 500 companies with the lowest price-to-sales ratios, the third in the 10 percent of S&P 500 stocks with the highest price-to-sales ratios and the fourth in an equal-weighted portfolio of the benchmark index’s 500 members. All four hypothetical portfolios were rebalanced each month.

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