Tweedy Browne, the deep value investment firm established in 1920, has updated its booklet, What Has Worked In Investing (.pdf). First published in 1992 and now updated for 2009, the booklet discusses over fifty academic studies of investment criteria that have produced high rates of investment return. Our interest in the booklet stems from its examination of a group of investment styles falling under the rubric, “Assets bought cheap,” in particular, Benjamin Graham’s “Net current asset value” method and the “Low price to book value” method.
Graham’s “Net current asset value” method
Says Tweedy Browne of Graham’s “Net current asset value” method:
The net current asset value approach is the oldest approach to investment in groups of securities with common selection characteristics of which we are aware. Benjamin Graham developed and tested this criterion between 1930 and 1932. The net current assets investment selection criterion calls for the purchase of stocks which are priced at 66% or less of a company’s underlying current assets (cash, receivables and inventory) net of all liabilities and claims senior to a company’s common stock (current liabilities, long-term debt, preferred stock, unfunded pension liabilities). For example, if a company’s current assets are $100 per share and the sum of current liabilities, long-term debt, preferred stock, and unfunded pension liabilities is $40 per share, then net current assets would be $60 per share, and Graham would pay no more than 66% of $60, or $40, for this stock. Graham used the net current asset investment selection technique extensively in the operations of his investment management business, Graham-Newman Corporation, through 1956. Graham reported that the average return, over a 30-year period, on diversified portfolios of net current asset stocks was about 20% per year
The booklet discusses a study conducted by Henry Oppenheimer, an Associate Professor of Finance at the State University of New York at Binghamton, in which he examined the returns of such stocks over a 13-year period from December 31, 1970 through December 31, 1983. Oppenheimer’s study assumed that all stocks meeting the investment criterion were purchased on December 31 of each year, held for one year, and replaced on December 31 of the subsequent year by stocks meeting the same criterion on that date. The total sample size was 645 net current asset selections. The smallest annual sample was 18 companies and the largest was 89 companies.
Oppenheimer’s conclusion about the returns from such stocks was nothing short of extraordinary:
The mean return from net current asset stocks for the 13-year period was 29.4% per year versus 11.5% per year for the NYSE-AMEX Index. One million dollars invested in the net current asset portfolio on December 31, 1970 would have increased to $25,497,300 by December 31, 1983. By comparison, $1,000,000 invested in the NYSE-AMEX Index would have increased to $3,729,600 on December 31, 1983. The net current asset portfolio’s exceptional performance over the entire 13 years was not consistent over smaller subsets of time within the 13-year period. For the three-year period, December 31, 1970 through December 31, 1973, which represents 23% of the 13-year study period, the mean annual return from the net current asset portfolio was .6% per year as compared to 4.6% per year for the NYSE-AMEX Index.
Perhaps most intriguing, though, was Oppenheimer’s conclusion about the relative outperformance of the loss-making stocks over the profitable ones:
The study also examined the investment results from the net current asset companies which operated at a loss (about one-third of the entire sample of companies) as compared to the investment results of the net current asset companies which operated profitably. The companies operating at a loss had slightly higher investment returns than the companies with positive earnings: 31.3% per year for the unprofitable companies versus 28.9% per year for the profitable companies.
We believe that Oppenheimer’s study presents a compelling argument for such an investment approach.
Low price in relation to book value
The second investment method falling under the rubric of “Assets bought cheap” is the “Low price in relation to book value” method. The booklet discusses a study conducted by Roger Ibbotson, Professor in the Practice of Finance at Yale School of Management and President of Ibbotson Associates, Inc., a consulting firm specializing in economics, investments and finance. In “Decile Portfolios of the New York Stock Exchange, 1967 – 1984,” Working Paper, Yale School of Management, 1986, Ibbotson studied the relationship between stock price as a proportion of book value and investment returns. To test this relationship, all stocks listed on the NYSE were ranked on December 31 of each year, according to stock price as a percentage of book value, and sorted into deciles. Ibbotson then measured the compound average annual returns for each decile for the 18-year period, December 31, 1966 through December 31, 1984.
Ibbotson found that stocks with a low price-to-book value ratio had significantly better investment returns over the 18-year period than stocks priced high as a proportion of book value. Tweedy Browne set out Ibbotson’s results in the following Table 1:
A second study conducted by Werner F.M. DeBondt and Richard H. Thaler, Finance Professors at University of Wisconsin and Cornell University, respectively, examined stock price in relation to book value in “Further Evidence on Investor Overreaction and Stock Market Seasonality,” The Journal of Finance, July 1987. DeBondt and Thaler ranked all companies listed on the NYSE and AMEX, except companies that were part of the S&P 40 Financial Index, according to stock price in relation to book value and then sorted them into quintiles on December 31 in each of 1969, 1971, 1973, 1975, 1977 and 1979. DeBondt and Thaler then calculated the investment return against the equal weighted NYSE Index over the subsequent four years for all of the stocks in each selection period. The four-year returns against the market index were then averaged.
The stocks in the lowest quintile had an average market price to book value ratio of 0.36 and an average earnings yield (the inverse of the P/E ratio) of 0.10 (indicating a P/E of 10). DeBondt and Thaler found a cumulative average return in excess of the market index over the four years of 40.7%. Meanwhile, the stocks in the highest quintile, those with an average market price to book value ratio of 3.42 and an average earnings yield of 0.147 (a P/E of 6.8), returned 1.3% less than the market index over the four years after portfolio formation.
Perhaps the most striking finding by DeBondt and Thaler, and one that accords with our view about the difficulty of predicting earnings with any degree of accuracy, was the contrast between the earnings pattern of the companies in the lowest quintile (average price/book value of 0.36) and the highest quintile (average price/book value of 3.42). Tweedy Browne set out DeBondt and Thaler’s findings in Table 3 below, which describes the average earnings per share for companies in the lowest and highest quintile of price/book value in the three years prior to selection and the four years subsequent to selection:
In the four years after the date of selection, the earnings of the companies in the lowest price/book value quintile increase 24.4%, more than the companies in the highest price/book value quintile, whose earnings increased only 8.2%. DeBondt and Thaler attribute the earnings outperformance of the companies in the lowest quintile to the phenomenon of “mean reversion,” which Tweedy Browne describes as the observation that “significant declines in earnings are followed by significant earnings increases, and that significant earnings increases are followed by slower rates of increase or declines.”
The booklet continues to discuss Tweedy Browne’s own findings confirming those of the studies described above, and a range of other studies that confirm the findings over different periods of time and in different countries. The findings form a compelling argument for an investment philosophy rooted in deep value and focused on assets, such as Greenbackd’s.
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What Has Worked in Investing, I find to be one of the most concise, research-based, indisputable proponents of value investing. I reference it frequently when investing.
In practice, I’ve found small cap value is still doing quite well. Comparing funds such as Vanguard’s VISVX to the S&P 500 still reveals massive outperformance.
One disappointing occurrence, however, is the performance of high dividend yield funds, which Tweedy’s article would support. Sadly, in real life, these funds have been getting spanked by the market lately.
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Thank you for sharing the information. It is something I have believed in ever since I read the original version of “Contraian Investment Strategies” by David Dreman. This PDF and the “Buffett Paradox” have for the past few years forever reinforced this investing approach. Over time, I have tweaked my model a bit further. I have found that screening for companies giving consistent 8/9 out of 10 year eps, sales/revenue, dividend, and cash flow seemed to do even better. Granted these are post 2009 investments, so in time my thesis may fail. However, I’m simply amazed at the number of quality companies that are thrashed and tossed aside by the talking heads and Mr Market. I rarely have to look too past my Value Line subscription to seek ideas. IMHO, the biggest advantage individual investors have is time (not to be confused with timing). That and a steady source of cash flow from dividends and savings allow the contrarian approach to succeed. Thank you again!
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My pleasure. Thank you for a great comment.
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[…] because that was what all the early research seemed to say (See, for example, Roger Ibbotson’s “Decile Portfolios of the New York Stock Exchange, 1967 – 1984,” Werner F.M. DeBondt and Richard H. Thaler’s “Further Evidence on Investor Overreaction and […]
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[…] that was what all the early research seemed to say (See, for example, Roger Ibbotson’s “Decile Portfolios of the New York Stock Exchange, 1967 – 1984,” Werner F.M. DeBondt and Richard H. Thaler’s “Further Evidence on Investor Overreaction […]
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[…] #split {}#single {}#splitalign {margin-left: auto; margin-right: auto;}#singlealign {margin-left: auto; margin-right: auto;}.linkboxtext {line-height: 1.4em;}.linkboxcontainer {padding: 7px 7px 7px 7px;background-color:#eeeeee;border-color:#000000;border-width:0px; border-style:solid;}.linkboxdisplay {padding: 7px 7px 7px 7px;}.linkboxdisplay td {text-align: center;}.linkboxdisplay a:link {text-decoration: none;}.linkboxdisplay a:hover {text-decoration: underline;} function opensingledropdown() { document.getElementById('singletablelinks').style.display = ''; document.getElementById('singlemouse').style.display = 'none'; } function closesingledropdown() { document.getElementById('singletablelinks').style.display = 'none'; document.getElementById('singlemouse').style.display = ''; } Can Anyone Find Index-Beating Mutual Funds? Maybe!Tweedy Browne Q2 CommentaryMy MoneyModel Indexed Account – How Are We Doing?Model Indexed Account – How Are We Doing?Tweedy Browne updates What Has Worked In Investing […]
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[…] value stocks in deciles (an approach possibly suggested by Roger Ibbotson’s study Decile Portfolios of the New York Stock Exchange, 1967 – 1984). They found that low price-to-book value stocks out perform, and in rank order (the cheapest […]
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[…] Richard H. Thaler, Chicago School economist and co-author (along with Werner F.M. DeBondt) of Further Evidence on Investor Overreaction and Stock Market Seasonality, and the “Thaler” in Fuller & Thaler Asset Management, has written an opinion piece for […]
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Have you considered that the majority of companies are in some kind of cyclical business – whether it be mining, manufacturing, oil, aircraft, semiconductors, cars, insurance, or banking?
What you call mean reversion I call the up cycle.
Mean reversion in earnings is natural in these industries because a strong period attracts competitors, increasing costs and driving overall industry profits down. Lots of the companies are projecting high rates of growth forever and that is unsustainable.
When the industry does go into a downturn the companies with staying power survive and the highly leveraged firms go bankrupt. The case for each industry is slightly different but in the end the result is the same: the companies that remained in the industry become stronger. This causes their earnings to grow a lot faster.
The theory shouldn’t be called “mean reversion.” In essence the results are the same but it should be quite obvious when you state it as “cyclical companies in downturns will turn up and cyclical companies in upturns will eventually turn down.”
I believe the result is less pronounced for the “upturn companies” in these results because more companies that are given premium valuations are given them because they are less cyclical.
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Yes, cyclical industry factors are one cause of mean reversion. The others include business specific factors (for example, a new CEO in a poorly performing company) and industry / business / product life cycle factors.
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[…] the earnings of high price-to-book value stocks. I usually cite this table from the Tweedy Browne What works in investing […]
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Fantastic stuff!!
Appreciated
I recommend sifting through the 60 odd pages in the tweedy report…
I’d love to see an updated report in 5 years time using the same criteria… Given the recent volatility I think abnormal returns would be far higher with a this new dataset… Someone want to give it a crack??
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[…] study on the performance of NNWC stocks, perhaps with holding periods in line with Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update for comparison. You can see Jae Jun’s Old School Value NNWC NCAV Screen here (it’s […]
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[…] over time. In support of this argument I cite generally Graham’s experience, Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update paper, Testing Ben Graham’s Net Current Asset Value Strategy in London, a paper from the business […]
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[…] Oppenheimer on Graham’s liquidation value strategy between 1970 and 1983, published in the paper Ben Graham’s Net Current Asset Values: A Performance Update, indicates that “[the] mean return from net current asset stocks for the 13-year period was […]
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[…] with Richard Thaler, Chicago School economist and co-author (along with Werner F.M. DeBondt) of Further Evidence on Investor Overreaction and Stock Market Seasonality, a paper I like to cite in relation to low P/B quintiles and earnings mean reversion. Thaler is […]
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[…] been a strategy similar to the annual rebalancing methodology discussed in Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update. That paper demonstrates a purely mechanical annual rebalancing of stocks meeting Graham’s net […]
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[…] the phenomenon of mean reversion was identified by Werner F.M. DeBondt and Richard H. Thaler in Further Evidence on Investor Overreaction and Stock Market Seasonality. DeBondt and Thaler examined the relative performance of quintiles of stocks on the NYSE and AMEX […]
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[…] not a difficult process. We need go no further than the methodologies outlined in Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update or Lakonishok, Shleifer, and Vishny’s Contrarian Investment, Extrapolation and Risk. I believe […]
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[…] Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update paper demonstrates, a purely mechanical application of Graham’s net current asset value […]
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[…] Risk paper, and the “Thaler” in Fuller & Thaler is Richard H. Thaler, co-author of Further Evidence on Investor Overreaction and Stock Market Seasonality, both papers I’m wont to cite. I’m not entirely sure what strategies LSV and Fuller […]
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[…] 18, 2009 by greenbackd In Ben Graham’s Net Current Asset Values: A Performance Update Professor Henry Oppenheimer examined the return on stocks selected using Benjamin Graham’s […]
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[…] are two studies relevant to the outcome in that experiment: Professor Henry Oppenheimer’s Ben Graham’s Net Current Asset Values: A Performance Update, which found “[the] mean return from net current asset stocks for the 13-year period [from 1970 […]
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[…] of low price-to-value stocks over higher price-to-value stocks – Roger Ibbotson’s Decile Portfolios of the New York Stock Exchange, 1967 – 1984 (1986), Werner F.M. DeBondt and Richard H. Thaler’s Further Evidence on Investor Overreaction […]
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[…] or liquidation play (here’s my post on Graham’s liquidation value methodology), and, as Professor Henry Oppenheimer demonstrated, the returns to a very simple buy-and-hold-for-a-year-and-repeat strategy will put investment […]
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[…] from it. As the various studies we have discussed recently demonstrate – Roger Ibbotson’s Decile Portfolios of the New York Stock Exchange, 1967 – 1984 (1986), Werner F.M. DeBondt and Richard H. Thaler’s Further Evidence on Investor Overreaction […]
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[…] in Testing the performance of price-to-book value, various studies, including Roger Ibbotson’s Decile Portfolios of the New York Stock Exchange, 1967 – 1984 (1986), Werner F.M. DeBondt and Richard H. Thaler’s Further Evidence on Investor Overreaction […]
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[…] plenty of attention from researchers in academia and industry, starting with Roger Ibbotson’s Decile Portfolios of the New York Stock Exchange, 1967 – 1984 (1986) and Werner F.M. DeBondt and Richard H. Thaler’s Further Evidence on Investor […]
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[…] returns. Value is a counterintuitive strategy. Glamour feels like a better bet than value, but studies have shown over and over again that value outperforms glamour or momentum. Tangible asset value – […]
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[…] 1992 Tweedy Browne, an undervalued asset investor established in 1920, produced a report What has worked in investing. The report described a number of academic studies of investment styles that have produced high […]
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[…] Tweedy Browne offers some compelling evidence for the asset based valuation approach here. […]
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Jonathan,
Avatar Holdings is a net-net (kind of).
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The update of the Tweedy Browne booklet continues a long and sorry tradition of updates that are not updates at all. In 60 pages, there are no more than three studies that include data post-1992 (the date of the initial booklet). Many studies end in the 1980s. One has to ask oneself: How relevant are these studies for today’s market? And why did TB bother with such a marginal update? To change the fonts and fancy up the layout?
Strange, because even a cursory look at The Journal of Portfolio Management and similar professional journals would uncover many a study that goes right up to the past five years, about what is (and is not) working in investing.
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If the NCAV strategy has been so successful (and there is no reason to believe it would not continue to be successful) in the absence of consideration of a catalyst, why is a catalyst needed today?
Is there any evidence for the use of a catalyst?
I’m just interested to know why half of your investment strategy has a compelling evidence base and the other half is (to my knowledge) unresearched at this time (appreciating the difficulty there would be in designing research to answer such a subjective question).
In bear markets, it is presumably easier to find NCAV stocks than a bull market, so in the next bull market if there are no NCAV stocks to be found, where would you put your money?
Thanks for sharing the Tweedy Browne research, very informative. Very interesting site.
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Dougs,
>Is there any evidence for the use of a catalyst?
The short answer is, “yes.” We’ve covered a number of studies that demonstrate that catalysts – liquidations, buybacks, takeovers, special dividends, capital returns, etc – are associated with abnormal positive returns. Two recent examples from Greenbackd are as follows:
*Previous buyback completion rates matter, which shows that stocks with high completion rates but low stock returns following previous buybacks enjoy abnormally large returns following a subsequent buyback announcement.
*Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors, which shows that the filing of a 13D notice by an activist hedge fund is a catalytic event for a firm that heralds substantial positive returns in the stock.
Both of these are examples of catalytic events that are independent of the underlying value proposition, but we think the search for a catalyst is particularly important in deep value situations. As Seth Klarman points out:
“Value investors are always on the lookout for catalysts. While buying assets at a discount from underlying value is the defining characteristic of value investing, the partial or total realization of underlying value through a catalyst is an important means of generating profits. Furthermore, the presence of a catalyst serves to reduce risk. If the gap between price and underlying value is likely to be closed quickly, the probability of losing money due to market fluctuations or adverse business developments is reduced. In the absence of a catalyst, however, underlying value could erode; conversely, the gap between price and value could widen with the vagaries of the market. Owning securities with catalysts for value realization is therefore an important way for investors to reduce the risk within their portfolios, augmenting the margin of safety achieved by investing at a discount from underlying value.”
>In the next bull market if there are no NCAV stocks to be found, where would you put your money?
Predominantly in cash. One of things we like most about this type of deep value investment is that the opportunities to invest dry up at the top of the market. Since we love buying stocks, we need something that acts to prevent us from buying when the market is overheating. Deep value does just that. You might have to sit on the sidelines for a few years when everyone else is making money, but when the crash comes, your powder will be dry.
Those are two great questions. Thanks very much.
G
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It’s interesting. I just browsed through Tweedy and Browne’s stock holdings at gurufocus.com, and am little surprised to see a bunch of “Buffet” stocks among their holdings.
I didn’t dig really deep, but I didn’t see ANY net-nets that I could find.
I understand that Marty Whitman says about 2/3s of his portfolio (or maybe just 2/3s of his holdings?) are in net-nets now. I should check these out I suppose. I’m looking for opportunities still.
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Could be an issue with the fund being too large for such stocks. Here’s the link to the SEC filing for those who are interested: Tweedy Browne’s 13F filing.
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I’ve been following your site for a while now and I’ve got to say that this article is probably the most significant/important posting that you’ve made. Not that your others aren’t great posts, but this one is just that important. Anything Tweedy Browne says you can bank on. Their words of advice are as important and Warren Buffett’s himself in my opinion.
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Thanks, Jim. We couldn’t agree more about Tweedy Browne.
G
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