By |Published On: March 6th, 2015|Categories: Value Investing Research|

Barry has a nice piece in the Washington Post asking a simple question:

What is the best valuation metric to assess if a stock is cheap or expensive?

Jack and I were honored to see that Barry highlighted our 2013 Journal of Portfolio Management paper:

Analyzing Valuation Measures: A Performance Horse Race over the Past 40 Years

You can download an old version of the paper here and there is a in-depth summary at the following link.

The chart below presents the key table from our paper:

Which Value Investing Metrics Should You Trust


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Barry’s comment on our paper:

Perhaps the most readable of these is from Wesley Gray and Jack Vogel: “Analyzing Valuation Measures: A Performance Horse-Race Over the Past 40 Years” (Drexel University, January 2012).

These papers (and others) have identified a ratio that has been described as the single most successful measure of valuation in terms of historical track record: EV/EBITDA.

Barry also highlights another great paper on the subject from Tim Loughran and Jay Wellman.

A close second is Tim Loughran and Jay W. Wellman’s “New Evidence on the Relation Between the Enterprise Multiple and Average Stock Returns.”

We did a deeper dive on this paper in the following blog post.

Here is my favorite chart from the paper:

ebit multiple results


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Conclusion

Buying cheap stocks has been a good strategy–at least historically. And it certainly seems that enterprise multiples are more effective, on average, than measures that are more commonly used (e.g., book-to-market, or price-to-earnings).

Who knows which metric will be the best in the future, but one lesson is clear: buy cheap stocks. And if you don’t have the stomach of patience do buy individual stocks, identify value investing funds, value investing etfs, or value-focused stock-pickers searching in the bargain bin of the market-place.

About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.