Turning Mongrels Into Show Dogs

Study shows downtrodden value firms, known as dogs, have outpaced high PTB growth companies annually by an average of 15.5% over the past 34 years. I would compare stock pickers to astrologers,' said Eugene Fama, professor of finance at University of Chicago. 'But I don't want to badmouth the astrologers. Mr Fama is one of the smartest brains in finance today.

His work on efficient-market theory has changed the way investors think about how markets work and has led to the wide acceptance of index funds. In 1992, together with Kenneth French, then of Yale University, he published a breakthrough study on the use of price-to-book (PTB) ratio as a predictor of a company's future stock performance. Fama and French's study showed convincingly that the lower the companys ratio of PTB value, the higher its subsequent stock performance tended to be. No other measures had nearly as much predictive power - not earnings growth, price/earnings, or volatility. Fama and French's data showed that downtrodden 'value' companies have outpaced high PTB growth companies annually by an average of 11-15.5 per cent over the past 34 years. I tested their theory on the Singapore market with data from the past five years. I found that, indeed, portfolios of 10 stocks with lowest PTB ratios had outperformed the market as well as portfolios of high PTB stocks by a wide margin. In other words, if you had consistently bought the most shunned stocks - the likes of CK Tang, Isetan, Hong Fok or United Engineers - in the past five years,

your portfolios would have beaten those who bought high-fliers like SingTel, Venture, SPH or MediaRing many times over. Dogs pay handsomely PTB ratio is the ratio of a companys market capitalization over the book value (BV) of its equities. The BV of equities is the total assets as recorded in a company's balance sheet minus its liabilities. It is almost similar to net tangible assets, except equities BV may include intangibles like goodwill of an acquired subsidiary, whereas NTA doesnt. Stocks with low PTB ratios are stocks which most investors would not be caught dead with. These are out-of-favor companies whose shares have been sold down such that their share price represent only a fraction of the value of assets as recorded in their balance sheets. But the problem is, investors or the market generally over-react when it comes to pessimism. Likewise, they over-react on the upside. This is borne out by the findings of my study. Let's say that between January 1997 and now, you had diligently sorted all the Singapore dollar stocks according to their PTB value every month. If you had bought one lot of shares in each of the 10 companies with the lowest positive PTB ratio every month, and held the portfolios for three months, on average, your portfolios would have made a return of 5.7 per cent. Portfolios of such stocks, better known as dogs, outran the portfolios of stocks whose share prices were trading way beyond their book values by 8.3 percentage points. And they outperformed the Straits Tunes Index by five percentage points.