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54 Figure 8-2 Price/Cash Flow Dividends, Appreciation & Total Retums January 1, 1970 - December 31, 1996 Low 2 3 4 P/CF Quintiles High Market □ Dividend Retum Appreciation Total Return or price-to-cash flow, over the top 20% by the same measurements. Secondly, the similarity of results is remarkable. The low-P/E strategy is somewhat more rewarding, returning 19.0% annually for the 27 years of the study vs. 18.8% for low price-to-book value and 18.0% for low price-to-cash flow. But all three value strategies handily beat the market and 8 1 outperform the best stocks in each case. Once again, we see the key ingredients of outperformance. Low price-to-cash flow and low price-to-book value have significantly higher dividends than the market and more than triple the dividend of the best stocks in each category, thereby providing a good part of total return. Too, look at the appreciation of the low price-to-cash flow and the low price-to-book value groupings. By this measurement, both groups not only outperform the highest stocks, but also the market handily. The accepted reason for buying "best stocks," much higher appreciation, is shown to be fallacious. Figures 8-2 and 8-3 again indicate that contrarian stocks give you the best of both worlds-higher appreciation and higher dividends. The
Boosting Portfolio Profits 165 Figure 8-3 Price/Book Value Dividends, Appreciation & Total Retums January 1, 1970 - December 31, 1996 P/BV Quintiles High Market □ Dividend Return □ Appreciation Total Return bottom quintile provides dividend returns three times as large as the highest P/E quintile, another easy win for the out-of-favor stocks. Figures 8-1 to 8-3 demonstrate that the conventional wisdom of setting radically different investment goals for conservative and aggressive investors is simply one more investment myth. Which brings us to another important investment rule: RULE 15 Dont speculate on highly priced concept stocks to make above-average returns. The blue-chip stocks that widows and orphans traditionally choose are equally valuable for the more aggressive businessman or -woman. Stocks classified as a "businessmans risk" by many brokerage firms, both because of their low dividends and high price-to-value ratios, often
tum out to be "bummers." As a group they consistently underperform the market. A better term might be "businessmans folly." Figures 8-1 to 8-3 go far to reject this concept. The strategies of buying the lowest 20% of stocks either by price-to-book value, or price-to-cash flow, as we have seen, hold up through both bull and bear markets. Buying and holding portfolios of the lowest price-to-cash flow and price-to-book value without any change in their composition for periods of two, three, five, and eight years (not shown) provide retums very similar to those of buying and holding the lowest P/E portfolio (Table 8-1). Investing in these two groups results in retums well above the markets, and sharply higher than the favorite stocks in each group for every period up to eight years."* The "best" stocks continue to underperform for these extended periods. It again demonstrates that you dont have to watch the market like a gunslinger, ready to slap leather at any new piece of information. Relax, youll probably make far more money by moving slowly. There is the collateral reward of not shooting yourself in the foot by moving quickly and incorrectly, as is often the case with pros. The final and one of the most important rewards of the "buy and hold" approach, as indicated with low P/E or the other low price-to-value strategies, is that lower transaction costs can result in a substantial increase in your capital over time. Transaction costs are often not recognized by investors but can be very expensive.* These are the eighths and quarters it costs you to buy or sell a stock. An example might help to demonstrate why. If a stock is trading at $35-351 and you wish to buy it, you would probably pay $3514. If you want to sell it, you would probably receive $35. Such costs can total 5% or more of capital in a year. The more commissions and transaction costs can be reduced, of course, the better your overall results. In my experience, the contrarian approach reduces transaction costs and commissions substantially. If the average transaction cost (the commission plus the difference in the bid/ask spread) is M of 1 % and the portfolio tumover is 100% a year, it costs you 2 % of your capital in 5 years, over 5% in 10. If you are a heavy trader with tumover say at 200% a year, the costs move up dramatically-10% in 5 years, 20% in 10. * There is always a spread between the bid (the price the buyer is willing to pay) and the offer (the price at which a seller is willing to sell you a stock). The larger the company, normally the smaller the spread. Also, spreads are smaller on the NYSE than on Nasdaq or other markets. A spread on a large NYSE stock 1 ike GM or Exxon might be 1 /8 or 1 /4 of a point; the spread by a Nasdaq dealer on a like-sized company might be 1 /4 or 1 /2 a point. But more ofthis in chapter 15.
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