November 21, 2017

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Outperformers likely to continue outperforming

price share

Continuing to ourperform – outperformers. This article follows on from, Book value to market price, wherein what successful investors use heuristics to shape their strategic decisions, was mentioned

  • The FT’s James Mackintosh reported recently: “Momentum has been the most rewarding bet of the past 40 years. It beat the market and outperformed other popular investment strategies including buying small companies, value investing and picking stocks that are cheap on measures such as price-to-book or price-to-earnings…

“It even beat the market after adjusting for the extra volatility caused by buying into bubbles and losing big when the bubbles burst.”

Bernstein reports that between January 1927 and March 2013 a portfolio of high-momentum stocks – those with high short-term returns – beat a comparable portfolio of low-momentum counters by an average of nearly 7 per cent a year.

    • Growth companies in general “are lousy stocks.” That’s because everyone already knows they are great companies, so they bid up the price of their stocks. “There is good evidence that investors in general pay way too much for this earnings growth.”

A classic 1993 study by Russell Fuller and colleagues showed that high PE growth stocks did not increase their earnings in subsequent years nearly enough to compensate for their high prices. “Growth stock investing is a losing proposition.”

    • If dividends are important to you, you are less at risk in a market catastrophe. Over the 1929-32 period American stocks lost on average 90 per cent of their value, but their dividend payments only fell by 50 per cent.

High-dividend stocks are also outperformers. A 2011 study by London Business School researchers of 19 nations over 113 years showed a consistently positive relationship, with those in the high-dividend category returning an average of 13.4 per cent a year, the lowest-yielders only 5.5 per cent.

    • Winning strategies may not be repeatable, or disappoint, because too much copycat money flows into them. The famous John Templeton “made out… like a bandit” because he was the first to see the potential in neglected “penny” stocks.
    • Because REITs – real estate investment trusts – have to distribute 90 per cent of their earnings as dividends, and can therefore only invest a small portion of their earnings in their operations, their dividends grow more slowly than those of other listed companies – “more slowly than inflation, in fact, by about 1 per cent per year.”
    • Political favouritism depresses long-term returns of some asset categories because it makes them more expensive to buy. Conservatives favour precious metals “in opposition to the spectre of paper fiat currencies that can easily be debased by evil governments,” while liberals “tend to favour alternative energy stocks and avoid the manufacturers of tobacco, alcohol and firearms.”
    • “Except in extraordinary circumstances, I don’t like corporate bonds.” Besides their equity-like behaviour in a market panic, there is an inherent conflict of interest between bondholders, whose only concern is the safety of their interest and capital at maturity date, and shareholders, always tempted to raise debt to boost equity returns.

The problem with most bonds, especially the higher-risk “junk” variety, is that they lose so much value at exactly the point when you need the most cash out of them to buy equities and other assets that have become cheap.

  • Avoid hedge funds. The market is overcrowded and they are “savaged by high fees.” Over the past decade “you would have done just as well investing mainly in [Treasury] bills, spiced with a soupçon of stocks, and at much lower cost.”
  • Bernstein favours the Dimensional US Large Cap Value fund, which passively invests in companies with the highest BTM ratings. Over the 15-year period to November 2013, the fund delivered average annual earnings growth of 9.31 per cent, compared to 7.69 per cent for the S&P 500.

Bernstein reckons that investors shouldn’t expect to achieve anything better over the long term than average growth, or something close to it, and even that will be difficult.

copyright: Martin Spring of OnTarget

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