WhatHasWorkedFundOct14Web

WHAT HAS WORKED IN INVESTINGDuring the period December 31, 1966 through December 31, 1984 covered in Table 1, thecompound annual return for the market capitalization weighted NYSE Index was 8.6%.Werner F.M. DeBondt and Richard H. Thaler, Finance Professors at University ofWisconsin and Cornell University, respectively, examined stock price in relation to bookvalue in “Further Evidence on Investor Overreaction and Stock Market Seasonality,” TheJournal of Finance, July 1987. All companies listed on the NYSE and AMEX, exceptcompanies that were part of the S&P 40 Financial Index, were ranked according to stockprice in relation to book value and sorted into quintiles, five groups of equal number, onDecember 31 in each of 1969, 1971, 1973, 1975, 1977 and 1979. The total number ofcompanies in the entire sample ranged between 1,015 and 1,339 on each of the sixportfolio formation dates.The investment return in excess of or (less than) the equal weighted NYSE Index wascomputed over the subsequent four years for all of the stocks in each selection period. Thefour-year returns in excess of or (less than) the market index were averaged. The studyresults and additional descriptive information are presented below in Table 2.Table 2:Market Price in Relation to Book Value for Companies Listed on the New Yorkand American Stock ExchangesRankCumulativeAverage Returnin excess of or(less than)Market Index4 Years afterPortfolioFormationCumulativeAverage Returnin excess of or(less than)Market Index4 Years prior toPortfolioFormationAverage MarketPrice/ BookValue atPortfolioFormation DateAverageEarnings Yieldat PortfolioFormation DateMarketCapitalization atPortfolioFormation Date(Millions)1 (Lowest price/book value)40.7% (25.8%) 0.36 .100 $1062 22.6 (3.0) 0.76 .149 3303 9.5 16.3 1.02 .169 4244 5.0 37.6 1.43 .180 5945 (Highest price/book value)(1.3) 76.2 3.42 .147 1,030The compound annual return in excess of the market index from the lowest 20% of thestocks, in terms of price/book value, was 8.91%. For each $1,000,000 invested, the lowprice/book value stocks returned $407,000 more on average than the market index in eachfour-year period.The authors point out the investment return reversion which occurred in the periodsexamined in their study. The average cumulative return for lowest price/book value stocksin the four years prior to portfolio formation was 25.8 percentage points less than themarket index. This group of companies, which had performed so poorly in the stockmarket, subsequently increased 40.7 percentage points more than the market index in the4