Study Explains Why Value Beats Glamour

By on October 9, 2010

John Reese recently wrote about a new study by the Brandes Institute explaining how value stocks outperform “glamour” stocks:

While many have assumed that value stocks outperform because they come with higher levels of risk, Brandes found otherwise. It examined how value stocks (which it defined as those with lower price/earnings ratios, using projected earnings for the next year) and “glamour” stocks (those with higher forward-looking P/Es) fared after beating or missing earnings expectations.

Its findings: “Prices rose for value stocks when they exceeded (or beat) earnings forecasts and, perhaps counterintuitively, when they missed expectations.” More popular glamour stocks, meanwhile, produced lower returns whether they beat or missed expectations, and, importantly, the trend held up regardless of whether the firm’s business was improving or declining.

That, Brandes concludes, shows value stocks outperform not because they are riskier, but instead because of behavioural biases that cause investors to put unrealistically high expectations on glamour stocks, and unrealistically low expectations on value stocks. “Over time,” the group says, “as the influence of these biases weaken, security prices revert away from extreme levels.” That means value investors who stay disciplined and rational can take advantage of opportunities caused by those unrealistic expectations.

The article concludes with three value stock candidates and their attributes; Carlisle Companies Inc. (CSL), Eli Lilly & Co. (LLY), and Reinsurance Group of America (RGA).

A link to an excerpt from the study is aslo included directly below. The study spanned from June 30, 1990 through June 30, 2009 and included the largest 50% of developed market companies.

Sources: The Globe and Mail, Brandes Institute
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