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Daily Speculations The Web Site of Victor Niederhoffer & Laurel Kenner Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter; a forum for us to use our meager abilities to make the world of specinvestments a better place. |
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05/23/2004
Investment Fables by Aswath Damodaran
Reviewed by Tim Melvin
Damodaran's newest work exposes the myth of "can't-miss" investment strategies. I have read several of his books on valuation and have agreed with some of it and disagreed with other parts, but the glowing recommendation from none other than our esteemed Chair on the front cover, no less, made this is a must-buy.
The professor debunks many myths, and he shoots at all styles: value, growth. No one is spared. I went right to the chapter on low price-to-book, as I have done a lot of asset-based investing over the years, and wanted to see how he debunked the myth. I am happy to say that he and I agree down the line on this one.
Damodaran finds that while low price-to-book strategy appears to work in studies, results suffer from high transaction costs and an incredibly wide range of returns across the universe of stocks trading below book. One must own ALL of them to achieve the resuls found in studies -- impractical, if not impossible.
He also finds that book value can be a subjective number based on various accounting practices, and may not in fact be an accurate measure of a company's net worth. He also finds that low price-to-book portfolios tend to lag in rising markets, performing well only in slow-to-down periods. The outperformance occurs in large chunks over short periods of time.
at the end of the chapter, Damodaran reports that a portfolio of stocks that trade below book, betas below 1.5, debt-to-equity (using market value, not book) and priced over 3 and return on equity over 8% have indeed outperformed the market for significant periods of time...something like 80% of the years observed. He also gave a list of stocks that met these criteria in October 2002. Eliminating the Canadian stocks from the list, I find that these stocks have appreciated 56% since then, after 2% transaction and slippage costs. The 30.22% annualized is in line with the Nasdaq 30.02% and handily beats the S&P 500's 21.14%.