Jack and I were reading a classic academic paper on value investing the other day: Contrarian Investment Extrapolation and Risk.
In this paper Lakonishok, Schleifer and Vishny–the 3 compadres that went on to form the behemoth investment firm LSV asset management–highlight an “obvious” empirical finding for all value investors out there.
The authors find that value stocks earn excess returns because investors over-extrapolate bad news and drive cheap stocks beyond fundamental value.
Jack and I update and expand the LSV results in our work “Analyzing Valuation Measures: A Performance Horse-Race Over the Past 40 Years”.
Our conclusion is no different than LSV–value kicks B–Double O–T–Y.
We all know value has worked historically. That isn’t new, but re-reading the old classics can be fun. For example, below is some text from page 1575 of the LSV text:
Walmart and Microsoft were expensive high-flying growth stocks in the early 90’s. Ironically enough, Microsoft and Walmart are now “value stocks” that nobody wants to own.
MSFT shows up as #3 on our quantitative value screen this month and Wal-mart is not too far down the list!!!
Who is rearing to buy MSFT and Wal-Mart today?
Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only.
Past performance is not indicative of future results, which may vary.
There is a risk of substantial loss associated with trading commodities, futures, options and other financial instruments. Before trading, investors should carefully consider their financial position and risk tolerance to determine if the proposed trading style is appropriate. Investors should realize that when trading futures, commodities and/or granting/writing options one could lose the full balance of their account. It is also possible to lose more than the initial deposit when trading futures and/or granting/writing options. All funds committed to such a trading strategy should be purely risk capital.
Hypothetical performance results (e.g., quantitative backtests) have many inherent limitations, some of which, but not all, are described herein. No representation is being made that any fund or account will or is likely to achieve profits or losses similar to those shown herein. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently realized by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or adhere to a particular trading program in spite of trading losses are material points which can adversely affect actual trading results. The hypothetical performance results contained herein represent the application of the quantitative models as currently in effect on the date first written above and there can be no assurance that the models will remain the same in the future or that an application of the current models in the future will produce similar results because the relevant market and economic conditions that prevailed during the hypothetical performance period will not necessarily recur. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results, all of which can adversely affect actual trading results. Hypothetical performance results are presented for illustrative purposes only.
Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
There is no guarantee, express or implied, that long-term return and/or volatility targets will be achieved. Realized returns and/or volatility may come in higher or lower than expected.
- The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).
- Join thousands of other readers and subscribe to our blog.
- This site provides NO information on our value ETFs or our momentum ETFs. Please refer to this site.