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Academic Research To Support Value Investing

Value investing is the technique of attempting to buy stocks that are trading at discounts to their intrinsic value. After purchasing undervalued stocks, value investors wait patiently for the market to fully appreciate the stock, allowing it to rise in price.

Prices fluctuate more than values – so therein lies opportunity.”

Value investing underpins much of the work we do at Sure Dividend.

Our quantitative ranking system – The 8 Rules of Dividend Investing – is heavily dependent on stock prices. All else being equal, a declining stock price will help a company in our investment universe to rank higher using the 8 Rules.

Why do we rely on value investing principles to make buy or sell decisions?

Simply put, value investing works. And there’s evidence to prove it.

Warren Buffett, the world’s most successful investor who manages Berkshire Hathaway’s investment portfolio, is a devoted value investor and often educates the public on the principles of value investing through Berkshire Hathaway’s annual reports.

Buffett – a value investor – has averaged ~20% returns for decades.

Aside from the anecdotal evidence of Warren Buffett’s fantastic investment returns, there is also plenty of academic evidence to show that value investing works.

This article will summarize some of the most insightful academic research on value investing by outlining the results of various studies performed by leading finance academics.

Value Investing Evidence #1: The Value Quintile Outperforms

Carbon Beach Asset Management Inc. is a Santa Monica, California-based registered investment advisor (RIA) firm that caters to accredited investors.

Back in 2014, the firm’s managing partner, Tobias Carlisle, delivered an insightful presentation to Google employees, where he summarized research on the outperformance of stocks with cheap valuations.

More specifically, Carlisle’s firm ranked a global universe of ~22,000 stocks based on average percentiles of price-to-book, price-to-earnings, and price-to-cash-flow ratios and measured their historical performance over very long periods of time (from 1980 to 2013).

The results of this historical research can be seen below.

Source: Carbon Beach Asset Management (called Eyquem Investment Management at the time of the presentation)

The glamour quintile – the 20% of stocks with the highest valuations – had the poorest performance. From there, the valuation quintiles progressed linearly, with the value quintile delivering the strongest performance.

This research shows that undervalued stocks tend to outperform the market, evidence that value investing can deliver alpha for investors.

Furthermore, this research was conducted on a global universe of ~22,000 stocks, which indicates that value investing is widely applicable across a wide variety of geographies and stock market sectors.

Value Investing Evidence #2: The Value DecileOutperforms

Building on the data in the last section, which showed that the value quintile – the cheapest 20% of stocks – tends to outperform the broader market, this section will provide evidence that the value decile – the cheapest 10% of stocks – also outperforms.

Josef Lakonishok, Andrei Shleifer, and Robert Vishny published “Contrarian Investment, Extrapolation, and Risk” in 1994, a fascinating study that drew many conclusions on value investing.

More particularly, the group’s research performed a statistical analysis of historical stock market performance relative to valuations.

The paper constructed hypothetical portfolios at the end of each April between 1968 and 1989 based on valuation deciles using the price-to-book, price-to-cash-flow, and price-to-earnings metrics.

After constructing said model portfolios, the authors then computed cumulative total returns for the 5 years following portfolio construction.

Data on the performance of each valuation decile can be seen below.

Source: Contrarian Investment, Extrapolation, and Risk

Note that the authors used the inverse of traditional valuation metrics. So, instead of the price-to-earnings ratio, they used the earnings-to-price ratio. The glamor decile is accordingly the 1st decile of stocks instead of the 10th decile of stocks.


While is can be difficult to see in the table above, the value decile outperforms. The following chart provides a visual summary of this trend using the same data.

Source: Contrarian Investment, Extrapolation, and Risk; chart created by author. Valuation deciles have been inverted to reflect the other research published in this article. In this chart, the 1st decile is the value decile and the 10th decile is the glamor decile.

In this study, the value decile outperforms. This supports the first study summarized in this analysis and affirms our belief that stocks with cheap valuations outperform the market (on average).

Value Investing Evidence #3: Value Stocks Grow Their Earnings Faster Than Glamor Stocks

There are only three ways for a stock to generate investment returns:

  • Dividend payments
  • Valuation changes
  • Growth in earnings-per-share (or book value, or other measures of intrinsic value)

One would think that the major source of investment returns for value stocks...


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