# Market darling vs. ugly ducklings



## skc (8 December 2014)

In this thread I want to just forward test a simple theory... 

On the market there are expensive stocks and there are cheap stocks. "Expensive" stocks enjoy high PE multiple, high growth expectations and lower dividends. Conversely, "cheap" stocks generally have lower PE multiple, low or negative growth expectations and (potentially) higher historical dividends.

Many investors are wired to look for cheap stocks, hoping for a rise in value. But I wonder if a basket of expensive stocks would indeed outperform a basket of cheap stocks over a 2-5 year timeframe. If it does, it means that the market actually priced the stocks correctly (i.e. stocks were expensive or cheap for a reason).

So I have picked 20 stocks that appeared expensive and 20 stocks that appeared cheap... it's nothing more than a superficial scan of PE and my shallow understanding of the stock. I will try to include some deliberated diversification amongst different sectors. I will also avoided resources, as changes in commodity price would over-ride any meaningful findings from this exercise. 

I will put up the 2 lists tomorrow... but in the mean time if you like to nominate some stocks for either list, please feel free to contribute (I don't guarantee it will be included).


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## DeepState (8 December 2014)

skc said:


> In this thread I want to just forward test a simple theory...
> 
> On the market there are expensive stocks and there are cheap stocks. "Expensive" stocks enjoy high PE multiple, high growth expectations and lower dividends. Conversely, "cheap" stocks generally have lower PE multiple, low or negative growth expectations and (potentially) higher historical dividends.
> 
> ...




Over time, low PE / PB / PCF has outperformed the mirror.  That does not mean it will do so in any 3-5 year window when the scenario you have outlined could, did and very likely will occur again.

What do you mean by 'correct' price?  Do you care about risk adjustment?  Maybe they rise more because that is the compensation required for taking on such stocks (actually, the opposite argument holds as low PB/E/CF tend to be more distressed, fall more in the initial market corrections etc.).

What matters in this discussion is cheap relative to intrinsic value.  A stock can be cheap whether the PE is high or low.  It just so happens that, for various reasons, low PB tends to align to cheap more so than for high PE on average through time. It will not always be the case and that relationship can be violated for years at a stretch.   I am leaving aside anything to do with momentum as you have not mentioned past price movement.


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## So_Cynical (9 December 2014)

skc said:


> I will put up the 2 lists tomorrow... but in the mean time if you like to nominate some stocks for either list, please feel free to contribute (I don't guarantee it will be included).




One of each.

Expensive: CPU - P/E 23.9

Cheap: MXI - P/E 5.3


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## KnowThePast (9 December 2014)

skc said:


> In this thread I want to just forward test a simple theory...
> 
> On the market there are expensive stocks and there are cheap stocks. "Expensive" stocks enjoy high PE multiple, high growth expectations and lower dividends. Conversely, "cheap" stocks generally have lower PE multiple, low or negative growth expectations and (potentially) higher historical dividends.
> 
> ...




Hi skc,

This was precisely the question that prompted me to write my software.

Low PB/PE/PS portfolios have outperformed their high value counterparts in pretty much every 5 year period, in pretty much all world markes, including emerging ones.

RY mentioned risk and volatility, but surprisingly, these portfolios have also often proved to be better in that respect as well.

My own backtesting in Australia market agrees with this research.

"Contrarian Investment Strategies" by David Dreman is a little outdated, but still accurate. It has a field day trying to destroy any credibility of MPT by comparing the results of various (mainly Low PE and PB) strategies.

High value stocks can be a good and invstment, and be under-priced even at high valuation. My data tells me that you will need more parameters that just a Value ratio to filter out successful ones.

A few months ago I would have recommended my portfolio for a version of Low Value test, but I am slowly moving away in a different direction.


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## odds-on (9 December 2014)

Hi skc,

I nominate NWH and NVT.

Cheers


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## The Falcon (9 December 2014)

These days when any punter can run value screens, and I would suggest the competition for bargains is fiercer I wonder how that changes to risk-reward dynamics. 

This is an interesting exercise and I will follow with interest.


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## systematic (9 December 2014)

Go for it, of course...but for mine; I'm happy enough that value has been satisfactorily shown to beat glamour - all over the world and over all sorts of time periods.

I'd only make the comment re: KnowThePast's view that value beats glamour in pretty much every 5 year period...is not necessarily incorrect (depends on your definition of "pretty much every") - it just makes the journey (of value investing) sound a little easier than it is.  Not that I think you meant it that way, KnowThePast!

 skc, you said, "Many investors are wired to look for cheap stocks..."  I'm not sure what you mean by "many" - but it certainly is not "most".  I don't think you meant it that way...but just wanted to make the observation.


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## Logique (9 December 2014)

I can't believe how far a stock like Iluka ILU has fallen. At some point stocks like this and BHP have to start getting attractive. 

Not that I'm saying we're at that point yet, but certainly ones to keep an eye on.


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## Triathlete (9 December 2014)

Logique said:


> I can't believe how far a stock like Iluka ILU has fallen. At some point stocks like this and BHP have to start getting attractive.
> 
> Not that I'm saying we're at that point yet, but certainly ones to keep an eye on.




I have been following ILU and believe it has further to fall $5.50 or lower
	

		
			
		

		
	



	

		
			
		

		
	
...not sure if this chart helps any.


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## KnowThePast (9 December 2014)

Hi Systematic,



systematic said:


> I'd only make the comment re: KnowThePast's view that value beats glamour in pretty much every 5 year period...is not necessarily incorrect (depends on your definition of "pretty much every") - it just makes the journey (of value investing) sound a little easier than it is.  Not that I think you meant it that way, KnowThePast!
> 
> skc, you said, "Many investors are wired to look for cheap stocks..."  I'm not sure what you mean by "many" - but it certainly is not "most".  I don't think you meant it that way...but just wanted to make the observation.





Yes, definitely not that easy for a number of reasons. It is certainly not what the majority does.

Although I also agree with skc that majority believe they are buying value. It's just that value tends to be something with high multiple that they believe is worth even more.

The kind of value I am talking about lives in the sewers of the stock market, hardly anyone wants to touch them.

Another important thing to remember is that there are hardly any studies done on this in Australia. Most of the research is based on American and European markets, which we believe also applies here. While the general theme of value beating glamour applies here, there are some differences to be aware of.


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## skc (9 December 2014)

DeepState said:


> Over time, low PE / PB / PCF has outperformed the mirror.  That does not mean it will do so in any 3-5 year window when the scenario you have outlined could, did and very likely will occur again.






KnowThePast said:


> Another important thing to remember is that there are hardly any studies done on this in Australia. Most of the research is based on American and European markets, which we believe also applies here. While the general theme of value beating glamour applies here, there are some differences to be aware of.




This is why I wanted to do this exercise.



KnowThePast said:


> Low PB/PE/PS portfolios have outperformed their high value counterparts in pretty much every 5 year period, in pretty much all world markes, including emerging ones.
> 
> My own backtesting in Australia market agrees with this research.




I will be delighted if you could share some of your methodology and findings. It'd be much more useful than my snapshot which will prove nothing.



DeepState said:


> What do you mean by 'correct' price?  Do you care about risk adjustment?




Correct = the stock deserves a high multiple, over the following 3-5 year period. No I don't care about risk adjustments in this simple exercise.



KnowThePast said:


> A few months ago I would have recommended my portfolio for a version of Low Value test, but I am slowly moving away in a different direction.




I initially wanted to use your current portfolio as the "cheap" basket... but some of them were simply too small and illiquid. That portfolio also overweight mining services a bit too much and I wanted more diversification.



So_Cynical said:


> Expensive: CPU - P/E 23.9. Cheap: MXI - P/E 5.3





odds-on said:


> I nominate NWH and NVT.




Thanks. Precisely the sort of stocks I am thinking about.


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## shouldaindex (9 December 2014)

Darlings:
Healthscope, NetComm, Medibank, Sydney Airport, Domino's, Regis Health, Corporate Travel, Freedom Foods, Capitol Health, REA Group, Nearmap, Vocus, Seek, TPG, Ramsay Healthcare, OzForex, CoverMore, Carsales, 1300 Smiles, G8 Education, GreenCross, Aristocrat Leisure, Resmed, Qube.

Ducklings:
Hills, AGL, Regional Express, JB Hi-Fi, Energy Action, The Reject Shop, CountPlus, UGL, Cardno, DWS, Myer, APN, Vision Eye, Carbcharge, PAS Group, LogiCamms, Mermaid Marine, STW Communications, Seven West Media, Chandler McLeod, Skilled, MetCash, Santos.

I should add, I've done comparisons of groups and the result is usually determined by the absolute top end 1 or 2 stocks. 

For instance (just a general prototype of what I'd expect over the long term):  40% lose more than half their value, 20% more lose value, 20% make gains but underperform the index, 10% outperform the index, and the best 10% go gangbusters.


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## systematic (9 December 2014)

KnowThePast said:


> Hi Systematic,
> 
> Yes, definitely not that easy for a number of reasons. It is certainly not what the majority does.
> 
> ...




...That's a good point - the majority (especially fundamentals based investors) probably do believe they are buying value.  I've never thought of it like that.  Far from (my) reality.  For example, for a brief period I'd look at what Roger Montgomery was calling a good value stock (on his freely available videos etc)...only to find that I hardly ever (if ever at all) had any of his picks in my rankings as a value stock.  And; that's a value fund manager.  Unless my value rankings are up the creek, of course.

Mmmm...I don't want to disagree entirely with your last paragraph...but there have been some good ones done on the Aussie market - not all to be found on SSRN though.


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## KnowThePast (9 December 2014)

systematic said:


> ...That's a good point - the majority (especially fundamentals based investors) probably do believe they are buying value.  I've never thought of it like that.  Far from (my) reality.  For example, for a brief period I'd look at what Roger Montgomery was calling a good value stock (on his freely available videos etc)...only to find that I hardly ever (if ever at all) had any of his picks in my rankings as a value stock.  And; that's a value fund manager.  Unless my value rankings are up the creek, of course.
> 
> Mmmm...I don't want to disagree entirely with your last paragraph...but there have been some good ones done on the Aussie market - not all to be found on SSRN though.




Could you please point me in their direction?

I've read a couple, but none were anywhere near as extensive as what you can find for the US ones.


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## KnowThePast (9 December 2014)

skc said:


> This is why I wanted to do this exercise.
> 
> I will be delighted if you could share some of your methodology and findings. It'd be much more useful than my snapshot which will prove nothing.




Hi skc,

I am way too selfish to post much of it on a public forum, but I'll offer some thoughts.

In my thread, I've previously detailed my analysis of Low PB stocks here (post #200 & #201):
https://www.aussiestockforums.com/forums/showthread.php?t=26890&page=10

This is roughly the process I follow when I test other strategies. It is never a clear cut test, which gives an answer. I look at it from many different angles with various additional criteria to see if it still holds up. Position sizing, hold period, averaging, brokerage, dividends, interest rates, stop losses, etc. can make a massive difference to a strategy, unless you stay fully invested and re-balance once a year.

Knowing which strategy you run, and what kind of shape it is likely to take, plays a part in these portfolio management decisions. Stop losses, position sizing, holding period etc. are very much dependant on what kind of strategy you run.

1. Value stocks outperform most years, even on risk adjustment basis.
2. They do not outperform by much, but it is very consistent and statistically significant.
3. There's different measure for value, and not all are equal.
4. for most strategies, out/under performance is especially noticeable at extremes.
5. Most studies and systems concentrate on stocks that are suitable for funds, there's limited data that's useful for retail investors. Unfortunately, these systems are expensive to build, so they are unlikely to become a target market any time soon.
6. a likely number of suitable opportunities is an important factor in position sizing.
7. fishing for data, which RY referred to is a very problem that you need to be extermely aware of when backtesting. There's never a guarantee that a great backtest result will have any relevance in the future. There's no right answer here, it is not an exact science. 
8.  shouldaindex made a good point, that top 1-2 stocks make the biggest difference. While true, removing these outliers (and from benchmark), still shows outperformance for cheap stocks (just a lot less). Getting some of these outliers in your portfolio will ultimately be the difference between great and slightly above average return.
9. Having a very bad first year makes it almost impossible to catch up.
10. Now, once you establish a strategy that has a positive expectancy and you are reasonably sure that it should continue into the future, you look at whether it is possible to improve the result with human judgement. It seems such an easy thing to do, all you need to do is exclude a few stocks that are hopeless. But in practice, it's a lot more difficult. There will regularly be a hopeless case that becomes a ten bagger after going nowhere but down the first few years. RY, thanks for the thread on Smart Beta. I am sceptical that it is a good idea for most even though in theory, as I said, it seems like an easy and perfectly logical thing to do.

There's a lot more. The main point I am trying to make is that it's not as easy as measuring whether cheap stocks outperform, there's a lot of moving parts.

My portfolio is a good example of some of these points. Being aware of point 9, I've made a decision to allocate capital over a 24 months period, rather than going all in. With a limitation of only 1 purchase per month, I had to cherry pick what I thought was the best opportunity. Backtesting back to my portfolio start date, the reason I am not currently ahead by about 30% is that I didn't buy 2 stocks that became multi baggers over this period. I've paid a very expensive price for my risk management. 

Speaking of risk management, I will post up some backtests on the stop losss thread soon, short on time these days.


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## Logique (10 December 2014)

Triathlete said:


> I have been following ILU and believe it has further to fall $5.50 or lower
> 
> 
> 
> ...



Thanks Triathlete, good work. I don't doubt that you are right. $5.00 looks strong support. It will be well worth a look if it gets to that level.


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## DeepState (10 December 2014)

High P/E vs Low P/E (top 30% in market vs bottom 30%) courtesy of Ken French.  Australia.  Value weighted.  Pls note the axis is logarithmic. You already know which line is which.




Rolling 2 yr annualized returns.  The lines cross all the time.




What will be gained from one sample?


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## Wysiwyg (10 December 2014)

DeepState said:


> High P/E vs Low P/E (top 30% in market vs bottom 30%) courtesy of Ken French.  Australia.  Value weighted.  Pls note the axis is logarithmic. You already know which line is which.



I don't believe the stock universe from 1975 would be the same all the way therefore how accurate are these tests?


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## KnowThePast (10 December 2014)

Wysiwyg said:


> I don't believe the stock universe from 1975 would be the same all the way therefore how accurate are these tests?




They would most likely rebalance at regular intervals, usually annually.

They could also have a buy/sell trigger.

It certainly wouldn't have been a buy and hold for 40 years strategy.


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## skc (10 December 2014)

DeepState said:


> High P/E vs Low P/E (top 30% in market vs bottom 30%) courtesy of Ken French.  Australia.  Value weighted.  Pls note the axis is logarithmic. You already know which line is which.
> 
> Rolling 2 yr annualized returns.  The lines cross all the time.




I can't really tell which line is which in your second chart.



DeepState said:


> What will be gained from one sample?




I guess part of this exercise was to force a learning on myself that I don't need to look for low PE stocks alone for investment. I am always too quick to dismiss stocks which I deem "high PE, much growth priced in". I wanted to select some stocks that appear "expensive" but still "undervalued". Be contrarian to the contrarian, if that makes any sense.

I know that it isn't going to prove anything statistically. 



KnowThePast said:


> 1. Value stocks outperform most years, even on risk adjustment basis.
> 2. They do not outperform by much, but it is very consistent and statistically significant...




Thanks KTP. Great amazing effort as always. You've gone through much more than I can hope to do in this thread.

I am very glad that the thread has generated much knoweldgeable discussion. However, I am going to abandon the original idea of the thread... which is simply interesting but not worthy of the time committment required.


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## DeepState (10 December 2014)

skc said:


> I can't really tell which line is which in your second chart.




  That's kind of the point.  They cross all the time meaning that over time horizons that would matter to you, choosing good stocks matters more than choosing those that reside within high or low price multiple classifications.



skc said:


> I guess part of this exercise was to force a learning on myself that I don't need to look for low PE stocks alone for investment. I am always too quick to dismiss stocks which I deem "high PE, much growth priced in". I wanted to select some stocks that appear "expensive" but still "undervalued". Be contrarian to the contrarian, if that makes any sense.




Hopefully the data helps you with that sense.  You don't have to trawl within low price multiple to find good opportunities.  There is a statistical edge.  But that edge is very small on a case by case basis.  If you've got a better idea than about 52/48 for a given stock, that idea overcomes the edge we are talking about.  Perhaps that will aid with your conviction to pursue the direction you want to head into.

Some argue that the market is too wide to cover well.  I don't know.  You seem to do it just fine.  Some also argue that low price multiple stocks tend to require a different kind of analytical/investment skillset than their mirror.  If you think that, then perhaps there is a preferred habitat.  It just doesn't have to be in low price multiple. But, then again, you pair trade and are possibly active at both ends given the strategy anyway.



skc said:


> I know that it isn't going to prove anything statistically.


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## KnowThePast (10 December 2014)

skc said:


> Thanks KTP. Great amazing effort as always. You've gone through much more than I can hope to do in this thread.
> 
> I am very glad that the thread has generated much knoweldgeable discussion. However, I am going to abandon the original idea of the thread... which is simply interesting but not worthy of the time committment required.




Thanks skc.


I have another idea then.

Here are the bottom 50 stocks sorted by PE out of my universe (which has most ASX revenue making stocks). I've only included stocks with market cap over $20m.

ALL, QBE, EGG, VTG, LTN, SHR, SGM, KRS, IMD, SDM, 
AAC, CND, EML, RQL, PBD, ECV, API, VAH, CKL, GXL,
GFF, ASL, EGN, GLB, SXL, BBG, DVN, HLO, AAX, MCP,
CRH, FUN, BOL, EHL, BLY, ARI, MLB, SBB, NWH, RMD,
MLD, MAH, WDS, VET, UOS, DCG, BYL, TSM, UGL, CTN

Could everyone have a go at selecting 20 stocks out of it. The purpose of the exercise is to see whether human judgement (smart Beta as RY put it), can beat automatic selection by tilting it in a more profitable direction.

By default, bottom 20 stocks will be selected, as the benchmark. Everyone can then fine-tune their portfolio by removing/adding any stocks out of the 50 in the list. 

I am happy to keep track of it, and report progress periodically. Entries close this week.

My entry will be the default bottom 20. Noone else can select that. My game, my rules.

All participants promise to buy me a beer in the future for the effort.

Who's in?


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## odds-on (11 December 2014)

skc said:


> I guess part of this exercise was to force a learning on myself that I don't need to look for low PE stocks alone for investment. I am always too quick to dismiss stocks which I deem "high PE, much growth priced in". I wanted to select some stocks that appear "expensive" but still "undervalued". Be contrarian to the contrarian, if that makes any sense.




http://www.amazon.com/gp/aw/d/1614272387/ref=redir_mdp_mobile/190-9620163-4504713

You have probably read the above book but there is a really great chapter in this book which talks about PE ratios, Philip's advice is do not focus on them, as they do not aid the speculator, instead focus on the business trends and industry trends. According to Philip there are four types of stocks:

1. Stocks trading at low yields that are cash generating businesses with increasing sales in a great industry.
2. Stocks trading at high yields due to the business/industry having an uncertain future.
3. Stocks of a business that are returning to normal earning power.
4. Stocks of a business that is failing and will hopefully liquidate.

Money is made on 1. and 3. the rest are more likely to lose you money. Wise words.

Why not buy a basket of market darlings and basket of stocks that are returning to normal earning power (i.e.no current PE but earning history)?

I like these threads, should have trained to be a quant.

Cheers.


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## shouldaindex (11 December 2014)

I only recognise about 20 of them: QBE, EGG, VTG, SGM, ECV, API, CKL, GFF, SXL, HLO, MCP, CRH, FUN, BOL, MLB, SBB, RMD, VET, UOS, UGL


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## shouldaindex (11 December 2014)

Ugly Duckling Screen (PE < 15, SP > -30%). Picked 10 of the most interesting to me:

SUL, TRS, VET, STO, UGL, MRM, CUP, EAX, HIL, MWR

Intuitively I find it hard to believe all 10 suddenly turned to rubbish.


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## craft (11 December 2014)

skc said:


> In this thread I want to just forward test a simple theory...
> 
> On the market there are expensive stocks and there are cheap stocks. "Expensive" stocks enjoy high PE multiple, high growth expectations and lower dividends. Conversely, "cheap" stocks generally have lower PE multiple, low or negative growth expectations and (potentially) higher historical dividends.
> 
> ...




A couple of thoughts.

To determine cheap or expensive you really need to consider what returns a company can make over its cost of capital (excess return), how sustainable that excess return is and how much capital (growth) can be applied at the excess rate.  When the valuation drivers are considered correctly there are cheap stocks on high PE’s and expensive stocks on Low PE’s etc.

The only way I know of determining valuation on fundamental grounds is via its internal cash generation potential.  For example I only think something is cheap if its discounted estimated future cash flows are more then I can buy it for.  BUT for this definition of value, placing a timeframe for the market to recognise the cheapness introduces a problem, knowing when or if the market will recognise the cheapness is not part of the valuation analysis – The market may never give you a chance to commute the cash flow and you will just have to rely on a very long term cash generation from the business to realise the required return.

So I question the validity of the valuation metric and the time frame.  But valuation metrics like Low P/E, P/B or P/R have shown some outperformance pretty consistently in the studies over set time periods.  Probably because the most hated stocks and the most loved stocks are both overdone, and make a big enough impact on those fairly arbitrary valuation measures.

Unless you are running a quant fund it’s not worth chasing the outperformance because you simply have to diversify too much to get the results. 

Should the concept influence your thinking? Not anywhere near as much as understanding the drivers of growth or how the market reacts to news if your profit generation is reliant on a sell transaction at some future date.

Can human judgement improve the quant approach as per KTP’s theory?  Yes and no. If you can nail the valuation drivers you’ll probably never look at the arbitrary valuation measures again and won’t walk this quant path. But if you do go the quant path, don't meddle with the proven results or you risk not getting the system identified advantage you are chasing.   

I see these fundamental ratio systems no different to a price based systems except they lack the time effectiveness of information and means for risk control which price based systems have and hence require large diversification (ie hold All the percentile) to ensure you extract the advantage.

Ps KTP not sure about some of those stocks being low P/E. Just at a quick glance  ALL,AAC,GXL,RMD,MLB,TSM all may be data issues or major business changes.


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## DeepState (11 December 2014)

Take a bow.  Welcome back, Craft.  Missed you.


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## skc (11 December 2014)

craft said:


> So I question the validity of the valuation metric and the time frame.  But valuation metrics like Low P/E, P/B or P/R have shown some outperformance pretty consistently in the studies over set time periods.  Probably because the most hated stocks and the most loved stocks are both overdone, and make a big enough impact on those fairly arbitrary valuation measures.
> 
> Unless you are running a quant fund it’s not worth chasing the outperformance because you simply have to diversify too much to get the results.
> 
> Should the concept influence your thinking? Not anywhere near as much as understanding the drivers of growth or how the market reacts to news if your profit generation is reliant on a sell transaction at some future date.




I use 2 process to search for investment opportunities. 
1. I read company announcements or other 3rd party sources talking about the company, and I investigate.
2. I run a market scan of low P/E, P/B, EPS growth etc and investigate those that meed the quantitative filters. I do that because of the commonly-accepted truism that "cheap" stocks outperform over time.

What that means is that I can easily miss out on many quality investments that are priced high as indicated by the quantitative filters. I suppose the simple answer is to adjust the filters so it doesn't exclude those "expensive" but undervalued companies.



craft said:


> Ps KTP not sure about some of those stocks being low P/E. Just at a quick glance  ALL,AAC,GXL,RMD,MLB,TSM all may be data issues or major business changes.




That's why I tend to take a grain of salt on the academic papers. It's difficult to clean up fundamental data across different companies by the best analysts. I doubt they are done well (if at all) by the researchers and I don't know how they would affect research outcomes.


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## KnowThePast (11 December 2014)

craft said:


> A couple of thoughts.




Yay! Craft is back.



craft said:


> So I question the validity of the valuation metric and the time frame.  But valuation metrics like Low P/E, P/B or P/R have shown some outperformance pretty consistently in the studies over set time periods.  Probably because the most hated stocks and the most loved stocks are both overdone, and make a big enough impact on those fairly arbitrary valuation measures.
> 
> Unless you are running a quant fund it’s not worth chasing the outperformance because you simply have to diversify too much to get the results.




PE, PB and PR are the most known and test strategies. Their effectiveness has been greatly reduced over time due to this. There are others that work better, although the problem remains the same for all of them. Effectiveness reduces over time as others catch on. Still, a quant would expect to perform better than a simple PE filter by finding other holes in the market.



craft said:


> Should the concept influence your thinking? Not anywhere near as much as understanding the drivers of growth or how the market reacts to news if your profit generation is reliant on a sell transaction at some future date.
> 
> Can human judgement improve the quant approach as per KTP’s theory?  Yes and no. If you can nail the valuation drivers you’ll probably never look at the arbitrary valuation measures again and won’t walk this quant path. But if you do go the quant path, don't meddle with the proven results or you risk not getting the system identified advantage you are chasing.
> 
> I see these fundamental ratio systems no different to a price based systems except they lack the time effectiveness of information and means for risk control which price based systems have and hence require large diversification (ie hold All the percentile) to ensure you extract the advantage.




I agree it is not the best approach. By in the absence of enough skill, I think it is a safe approach that has a good chance of generating a return above an index.



craft said:


> Ps KTP not sure about some of those stocks being low P/E. Just at a quick glance  ALL,AAC,GXL,RMD,MLB,TSM all may be data issues or major business changes.




Excellent point. Most of the research wouldn't have filtered these anomalies out properly. But, the outperformance of those strategies is shown despite having these kind of stocks in.

It seems that a simple way to improve an automated system is to remove these exceptions manually. Surprisingly, it doesn't necessarily improve the result.

Similar to adjuvants in vaccines. Taking them out reduces the effectiveness, even though there's no reason for them to be there. Here's a good quote about it:

“Adjuvants have been whimsically called the dirty little secret of vaccines [4] in the scientific community. This dates from the early days of commercial vaccine manufacture, when significant variations in the effectiveness of different batches of the same vaccine were observed, correctly assumed to be due to contamination of the reaction vessels. However, it was soon found that more scrupulous attention to cleanliness actually seemed to reduce the effectiveness of the vaccines, and that the contaminants – “dirt” – actually enhanced the immune respnse.”


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## craft (11 December 2014)

skc said:


> I use 2 process to search for investment opportunities.
> 1. I read company announcements or other 3rd party sources talking about the company, and I investigate.
> 2. I run a market scan of low P/E, P/B, EPS growth etc and investigate those that meed the quantitative filters. I do that because of the commonly-accepted truism that "cheap" stocks outperform over time.
> 
> What that means is that I can easily miss out on many quality investments that are priced high as indicated by the quantitative filters. I suppose the simple answer is to adjust the filters so it doesn't exclude those "expensive" but undervalued companies.




Here’s some irony for you.

I scratch and fart around with all different sorts of scans and sources for putting new ideas across my radar but I consider the ultimate scan for value to be *Significant New Highs*.  It might sound contradictory for a value investor and sure it throws up a heap of expensive stuff as well, but it’s a failsafe that anything I should be looking at _now_ can’t get past and has probably been the first identification on many of my more successful valuation oriented purchases. 

The trick though with a new highs scan is that it identifies both diamonds and coal as carbon – you have to be able to distinguish between the two with some other process/judgement.


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## DeepState (11 December 2014)

craft said:


> *Significant New Highs*




It is very real.  You are profiting from others cutting their winners too early (and keeping their losers too long).


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## Huskar (16 December 2014)

craft said:


> Here’s some irony for you.
> 
> I scratch and fart around with all different sorts of scans and sources for putting new ideas across my radar but I consider the ultimate scan for value to be *Significant New Highs*.  It might sound contradictory for a value investor and sure it throws up a heap of expensive stuff as well, but it’s a failsafe that anything I should be looking at _now_ can’t get past and has probably been the first identification on many of my more successful valuation oriented purchases.
> 
> The trick though with a new highs scan is that it identifies both diamonds and coal as carbon – you have to be able to distinguish between the two with some other process/judgement.




Just wanted to say thanks craft - your posts are very thought provoking as always.

A screen (or call it coattailing) I like to use is to follow releases / letters / substantial shareholder notices from fund managers or others I respect and cherry-pick their ideas, especially if they have not performed yet as thought. The difficulty then of course is being able to stand back and evaluate the business in your own right without being influenced by their thoughts (ie beware of social proof).


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