Monday, August 14, 2006

Value matters: Low PE stock returns pummel market averages!

If you needed more evidence or confirmation that stock value matters, i.e. not paying too high a PE ratio for stocks, some late-breaking research confirms, once again, that "value" stocks beat up on expensive "growth" stocks.

A report recently released by RBC Dominion Securities confirmed that a portfolio of the cheapest 20% of the equity universe has, since 1980, far outpaced the rest of the market. This performance contrasts even more markedly with the most expensive 20% of the market.

Total returns for those one-fifth of companies with the lowest price-earnings ratios in the S&P500 beat the index by 3.5% annually, and trampled the 20% most expensive part of that same market by 6% annually.

In Canada, the example was even more extreme, with the S&P/TSX composite index used as the equity universe. There, the cheapest one-fifth of companies soared past the index by 5% per annum, and trashed the most expensive quintile of companies, by 15% annually.

Furthermore, this performance is remarkably consistent over time: every five year period over that time frame saw the cheaper stocks outperform, except for a single five year period (the bubble years of 1995-1999 and only within the S&P500), and even then, this was only minor and only against the most expensive quintile of stocks.

Perhaps this can form the basis for a new "enhanced ETF" product.


The Confused Capitalist

1 comment:

MillionDollarCountDown said...

Good discussion. I had to refer it in one of my post. I am not always in the low P/E ratio camp. However, do consider this to be an important parameter.