The Less You Pay, The More You Earn

July 24, 2014 4:53 PM

Popular stocks tend to be expensive stocks. The data from “What Works on Wall Street” shows that betting on popular, expensive stocks is a horrible investment strategy over the long term. In the new edition of the book, I showed that using several value factors works much better than relying on just one or two alone. By looking at how a stock scores on several value factors, we find that it gives us a better guide to which stocks are truly cheap and conversely which stocks are truly expensive.

We created a Value Composite which looks at a stock’s PE; price-to-sales; EBITDA/Enterprise Value; Free cash flow/Enterprise Value and Shareholder Yield, which is the dividend yield plus any net buy backs from the previous 12 months. We equal weight each factor and score stocks on a scale of 1 to 100, with stocks ranked 1 being the cheapest in the universe and stocks ranked 100 being the most expensive.

Let’s focus exclusively on our O’Shaughnessy Large Stocks Universe, which is made up of stocks whose market capitalization is greater than the O’Shaughnessy All Stocks Universe. Currently those stocks with market cap’s greater than $7.5 billion qualify as large stocks. As you can see from the table below, over the last 50 years the results are fairly staggering—if you bought the most expensive popular stocks and took inflation into account, your $10,000 investment in the 25 most expensive large stocks would have sunk to $3,324, wiping out nearly 70 percent of your accounts value over a 50 year period! If you look at the 10 percent of stocks that were most expensive, you still lost money, turning $10,000 into an inflation-adjusted $7,744! Had you simply put the money in an equal-weighted index that invested in all Large Stocks, your $10,000 would have grown to $200,600.

How about the Ben Graham’s of the world, who insist on only buying the cheapest stocks in the world? Had our committed “been down so long that it looks like up to me” lover of cheap stocks diligently bought the 25 cheapest large stocks, their $10,000 would have grown to an inflation-adjusted $2,762,423, NEARLY 14 TIMES the value of simply investing in all large stocks!

What’s fascinating is that anybody with a library card could have been investing this way since 1934 when Ben Graham and David Dodd published their book “Security Analysis.” Now, they looked at cheapness different then I do, but the central tenet that cheap stocks outperform expensive ones has been around for 80 years, yet we continue to prefer the colorful story stock even in the face of overwhelming evidence to the contrary. 

Naming Names

What current market favorite gets a perfect 100, making it the most expensive of all large stocks? $TWTR (I should Tweet that) other expensive names are $BMRN, $TSLA, $LNKD, $UA, $CRM and $SBAC.

Now, how about the cheapest? Given the misadventures of their President, it should not surprise us to find that it is $OGZPY, with a value score of 0.1. Other super cheap names are $TRV, $ALL, $HPQ, $STX, $CB, $NOC and $JPM. 

Recommended for You