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A year ago I wrote a post on the returns to negative enterprise value stocks.

Zero Hedge screened Russell 2000 companies finding 10 companies with negative enterprise value, and then further subdivided the screen into companies with negative, and positive free cash flow (defined here as EBITDA – Cap Ex). Here’s the list (click to enlarge):

Including short-term investments yields a bigger list (click to enlarge):

Like Graham net nets, negative EV stocks are ugly balance sheet plays. They lose money; they burn cash; the business, if they actually have one, usually needs to be taken to the woodshed (so does management, for that matter). Frankly, that’s why they’re cheap.

Just for fun, I made four throw-away predictions:

  1. All portfolios beat the market
  2. Portfolio 1 outperforms Portfolio 2 (i.e. all negative EV stocks outperform those with positive FCF only)
  3. Portfolio 3 outperforms Portfolio 4 for the same reason that 1 outperforms 2.
  4. Portfolios 1 and 2 outperform Portfolios 3 and 4 (pure negative EV stocks outperform negative EV including short-term investments)

Here are the results:

1. Negative Enterprise Value Portfolio

2. Negative Enterprise Value Portfolio (Positive FCF Only)

3. Negative Enterprise Value (Inc. Short-Term Investments) Portfolio

4. Negative Enterprise Value (Inc. Short-Term Investments) Portfolio (Positive FCF Only)

I’m scoring the predictions as follows:

  1. All portfolios beat the market (Right)
  2. Portfolio 1 outperforms Portfolio 2 (i.e. all negative EV stocks outperform those with positive FCF only) (Wrong)
  3. Portfolio 3 outperforms Portfolio 4 for the same reason that 1 outperforms 2. (Wrong)
  4. Portfolios 1 and 2 outperform Portfolios 3 and 4 (pure negative EV stocks outperform negative EV including short-term investments). (Right)

Here are the links to the four virtual portfolios at Tickerspy that track the performance:

  1. Zero Hedge Negative Enterprise Value Portfolio
  2. Zero Hedge Negative Enterprise Value Portfolio (Positive FCF Only)
  3. Zero Hedge Negative Enterprise Value (Inc. Short-Term Investments) Portfolio
  4. Zero Hedge Negative Enterprise Value (Inc. Short-Term Investments) Portfolio (Positive FCF Only)

See my earlier post on the Returns to Negative Enterprise Value Stocks

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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A great piece from MebFaber on the probabilistic median real returns to different CAPE levels:

1

An ugly period for US equities approaches.

Read Probabilistic Investing.

Low bond yields have in the past been bad, not good, for equity returns.

See my earlier post on the Fed model “How predictive is the Fed model?

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

The Hong Kong University of Science and Technology Value Partners Center for Investing has examined the performance of value stocks in the Japanese stock market over the period January 1975 to December 2011. They have also broken out the performance of value stocks during Japan’s long-term bear market over the 1990 to 2011 period, when the stock market dropped 62.21 percent.

The white paper Performance of Value Investing Strategies in Japan’s Stock Market examines the performance of equal-weight and market capitalization weighted quintile portfolios of five price ratios–price-to-book value, dividend yield, earning-to-price, cash flow-to-price, and leverage-to-priceexcluding the smallest 33 percent of stocks by market capitalization.

The portfolios were rebalanced monthly over the full 37 years.

The authors find the value quintile of equal-weighted portfolios book-to-market, dividend yield, earning-to-price, cash flow-to-price, and leverage-to-price generated monthly returns of 1.48 percent (19.3 percent per year), 1.34 percent (17.3 percent per year), 1.78 percent (23.6 percent per year), 1.66 percent (21.8 percent per year) and 0.78 (9.8 percent per year) percent in the 1975–2011 period.

The returns diminished over the 1990 to 2011 period. The value quintile of equal-weighted portfolios book-to-market, dividend yield, earning-to-price, cash flow-to-price, and leverage-to-price generated monthly returns of  0.84 percent (10.6 percent per year), 0.78 percent (9.8 percent per year), 1.31 percent (16.9 percent per year), 1.13 percent (14.4 percent per year) and 0.0 percent (0.0 percent per year) in the 1990–2011 period, respectively. In contrast, the Japanese stock market lost 62.21 percent.

They find similar results for market capitalization-weighted portfolios sorted by these measures, as well as for three-, six-, nine-, and twelve-month holding periods (excluding the leverage-to-price ratio).

They also investigated the cumulative payoff in dollar terms of investing $1 in the portfolios having the highest values of our value measures with monthly portfolio rebalancing in the 1980–2011 period. Value investing strategies based on stock’s book-to-market, dividend yield, earning-to-price , cash flow-to-price , and leverage-to-price grew $1 into $115.98, $81.88, $433.86, $281.49, and $6.62 respectively, while the aggregate stock market turned $1 into a mere $2.76, in the 1980–2011 period. This implies that these value investing strategies rewarded investors 42.0, 29.6, 157, 102 and 2.40 times what the Japanese stock market did. The effective monthly compound returns of the various investing strategies are 1.25 percent, 1.16 percent, 1.60 percent, 1.48 percent and 0.49 percent, while the aggregate stock market only delivered 0.27 percent in this period.

Japan Value

Four out of five value investing strategies actually rewarded investors with positive returns in the bear market that spanned two decades from 1990 to 2011, turning $1 into $4.77, $4.25, $17.17, and $10.91, implying profits of 377 percent, 325 percent, 1617 percent, and 991 percent respectively, while the stock market plunged 62.21 percent after reaching its peak in January 1990. In addition, every one of these value investing strategies continued to generate positive returns between the pre-global financial crisis peak in 2007 and December 2011.

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

The CFAInstitute blog Inside Investing has a great post on the returns to negative enterprise value stocks. Alon Bochman, CFA has investigated the performance of all negative enterprise value (“EV”) stocks trading in the United States between March 30, 1972 and September 28, 2012. He used balance sheet data from Standard & Poor’s Compustat database and merged these data with price data from the database maintained by the Center for Research in Security Prices (CRSP). He then calculated historical EVs for every company every month, as well as matching forward 12-month returns. Says Alon:

I found 2,613 stocks that at one point or another traded at a negative enterprise value between 1972 and 2012 (Microsoft, unfortunately, was not among them). The list has one entry per stock-month. That is, a stock that has traded at a negative enterprise value three months in a row will appear on the list three times. Each time is a different investment opportunity with its own forward 12-month return. The average stock spent 10.17 months (not necessarily consecutive) in negative EV territory. Thus, the list shows a total of 26,569 opportunities to invest in negative EV stocks.

The average return across all 26,569 opportunities was 50.4%. That is, if you had diligently watched the market over the last 40 years and invested $1,000 into each negative EV stock each month, your average investment would be worth $1,504 after holding that investment for one year, not including trading costs, taxes, and so on. Not bad!

Most of the opportunities are in micro caps with limited liquidity:

Returns by Market Cap -- Negative EV Investing

Alon notes that these opportunities have come up with some regularity and have usually provided attractive returns but have on occasion lost a great deal as well:

Average 12M Returns on Negative EV Stocks by Entry Year

Read Returns on Negative Enterprise Value Stocks: Money For N0thing?

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

Further to this post Value Badly Lagging Glamour: The Value Premium Is Now A Discount Saj Karsan requested a calculation showing the value premium using EBIT/EV:

This chart shows the average annual value premium calculated using EBIT / EV (decile 10 — decile 1) from the largest 50 percent of non-financial stocks listed in the US for the period 1999 to present.

EBIT Value PremiumThe horizontal red line is the average EBIT/EV value premium for the period at 5.4 percent. 2009 aside, the value premium has been negative since 2007 (although there is a very small premium for the incomplete 2013 year to date). Even so, the magnitude of the return in 2009 means that, in aggregate since 2007, the value premium is still slightly positive.

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

Two interesting charts from The Brandes Institute’s annual Value versus Glamour update for 2013. The first exhibit (2) shows the disappearance of the value premium over the last five years, and its inversion over the last two years. The yellow dotted line shows the average returns to the ten decile portfolios of stocks ranked by price-to-book value from 1968 to 2012. It demonstrates that, historically, the higher the price-to-book value, the lower the returns. The differential between the returns to the stocks in decile 10 (the “value” portfolio) and decile 1 (the “glamour” portfolio) is the value premium. That relationship seems to have broken down since 2007 (shown in blue), and inverted since 2010 (shown in red). The value premium is now a value discount!US Value Premium

The second exhibit (3) shows the rolling five-year annualized relative performance of value over glamour. In the last two rolling five-year periods, value stocks in the U.S.–marked in yellow–have delivered their worst relative performance in the 32 years of data from 1980. The Non-U.S. value stocks have continued to outperform.Rolling Five-Year Value versus GlamourAs the second exhibit demonstrates, it’s unusual for value to underperform glamour by so much and for so long. The last period of underperformance occurred in 2000, and it wasn’t as deep or prolonged. One possible explanation is that low p/b value strategies are now so well known and low p/b value stocks are so picked over that value investors have to do something special to outperform. More likely is that this is a brief period of underperformance at the tail end of a bull market and the relative performance of value over subsequent periods will compensate.

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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