There are perhaps as many alternative or even opposing views on stock-market investing as there are quoted stocks. Not for the first time, I find myself taking issue with an article written on the subject - in this case, Chris John's Serious Money column last week titled "Forget investment styles and focus on logic".
The title flattered to deceive as investors surely found themselves none the wiser about the theme at the end of the piece. That was a pity, as the article grabbed one's attention (well, mine at least) with an opening discussion on the plethora of investment styles employed in the fund management industry, from growth to value to small-cap to sector-based investing.
The author also, and perhaps not unfairly, suggested much of the industry ends up chasing the latest "investment style" (or fad), which generally involves "departing from sound investment principles".
While I might point out that this unfairly tars all investors with the same brush, one could have no great issue with this line of deduction overall.
My main bone of contention was with the article's conclusions. The first conclusion was: "The best investment style is simply to buy something that you have good reason to believe is likely to go up in price." And that was it.
I checked to see if I had missed something. Where was the "focus on logic" in selecting stocks that "are likely to go up" or the very necessary discussion on solid fundamental business values that readers would surely expect an informed opinion on - such as high and well-covered dividend yields, high earnings yields (or low p/e ratios) on companies in stable industries, strong and sustainable cash flows, industry positioning, returns on capital, track records and, perhaps most importantly of all, the benefits of, or indeed necessity of, diversification in stock market investing.
The second conclusion - that "all the available evidence suggests that much of the effort to develop an investment style is a complete waste of time" - is simply at odds with the mountain of research available to the interested private investor that suggests otherwise.
This research is available not just to professional institutional investors but also to private investors who have an interest and are willing to put in some modest effort.
To quote the US billionaire investment guru Warren Buffett - the man with a near monopoly on great investment phrases - what is needed is "a sound investment framework for making decisions and the ability to keep emotions from corroding that framework". Let's get some facts on the "investment framework".
We in Merrion completed a reasonably comprehensive study on a number of approaches to investing in the FTSE 100 - which consists of the 100 leading quoted companies listed on the London Stock Exchange - from October 1994 to October 2003.
We believe it is a fairly representative period to analyse, given the various bull and bear market cycles that prevailed over that period.
We examined what returns could have been produced by:
(i) listing the top 75 shares from the FT 100 by market value;
(ii) selecting from that list the 15 shares that offered the best value as defined by either the p/e ratio, the price/cash ratio or dividend yield;
(iii) assume those 15 shares were held for a full year and that the portfolio was then re-balanced annually.
The table shows that a portfolio of 15 stocks with the lowest p/e ratios purchased from the UK's 75 largest quoted stocks and reviewed annually delivered an annual return of 13.7 per cent including dividends, compared to an annual return from the FT 100 index of 7.3 per cent over the same period.
The approach does not win every year but the evidence suggests that it works well enough given time and, perhaps more importantly, places an investor in a good position to weather the emotional ride that is part of equity investing.
A more comprehensive study on these approaches in the US markets, covering a 26-year period from 1970-96, was completed by David Dremen and detailed in his excellent book titled Contrarian Investment Strategies - still in print - should remove any doubt that the results of our FTSE 100 study were perhaps just a fluke of timing.
The fact is that stock market investors consistently and predictably over-react to bad news, which can depress particular shares in the short-term. The value-based approach outlined above simply provides a framework within which to take advantage of this market characteristic - in essence allowing an investor, on average, to buy low and sell high.
It should be emphasised that the universe of large-cap stocks is a good one for value investing. The FTSE 100 contains companies of enormous size and diversification, which provides them with staying power in difficult times. Hence, large-cap stocks are more likely to recover following setbacks.
Investors would also benefit if newspapers could publish, even on an annual basis, listings of stocks based on the relatively simple value characteristics I have outlined above, with perhaps a follow-up analysis from time to time. This would be a significant step in providing readers with a real equity education service and would balance the traditional newsflow-driven commentary of the topic.
Rory Gillen is head of research in Merrion Stockbrokers. A free copy of Merrion's FT 100 Value study is available from catherine.finn@merrion-capital.com.
