The Case for Long-Term Value Investing

A guide to the data and strategies that drive stock market success

Jim Cullen

• Publisher: Harriman House
• Year: 2022
• ISBN:
  9780857199485
• Topic: Betriebswirtschaft
• Subtopic: Aktien

Value investing moves in and out of favour, but the data doesn't lie. It has always worked, and will continue to work — as long as investors apply a value discipline and invest for the long term.In The Case for Long-Term Value Investing, experienced Wall Street pro Jim Cullen presents the eye-opening data that backs this up, explaining how investors can use the value approach for successful investing today, as well as sharing a wealth of fascinating stories from his time on the Street.Discover: The true principles of value investingJim's stock-picking method in detailInspiring case studies of successful value investmentsHow to apply the value discipline through practical strategies. The Case for Long-Term Value Investing also includes a concise history of the last 100 years of market history — showing just how crazy the market can be — with a review of bear markets, recessions, bubbles, melt-ups, interest rates, and much, much more. The Case for Long-Term Value Investing is the ultimate introductory guide to how and why value investing works, how to understand the markets, and how to be a successful investor.

Section Four: Picking the Stocks

10. Research Process

The first part of stock picking is research. The investor needs to find stocks in which to invest.

There is a huge universe of stocks from which to choose and the research process helps the investor to winnow down that universe into a smaller number of stocks to research further, and then an even smaller number of stocks to add to the portfolio.

When starting with a new portfolio, a good number of stocks to have in a portfolio for adequate diversification is 30–35, generally equally weighted, with no more than 15% of the portfolio allocated to any one industry, to avoid concentration risk.

The investment process starts by running screens to come up with companies to analyze further. The universes screened include the S&P 500, Russell Indexes, Value Line, various international indexes, and others.

This chapter reviews some of the various statistical measures used to screen stocks, of course starting with the three major investment disciplines: price-to-earnings, price-to-book, and dividend yield.

Price/Earnings Multiple

P/E multiples historically have swung from lows of roughly 10x earnings to highs of 20x+ earnings over time. The interest is not the absolute level of P/E multiple, but rather investing in stocks that are selling at a 20–50% discount to the P/E of the overall market (S&P 500). When a stock appreciates to where its P/E multiple exceeds the market average, the stock becomes a candidate for eventual sale and replacement in the portfolio.

Price/Book

We saw in the original study of the disciplines in Section Two that the historical performance of Price/Book is very competitive with dividend yield and Price/Earnings. This is surprising in that today, book value is not used as much because many stocks—in industries like technology, healthcare and consumer products—sell at a very high price relative to their book. For this reason, P/B is more important for certain industries like airlines and metals. In general, for those industries, stocks selling at 2x book or less are preferred.

Dividend Yield

For strategies where it is a primary focus, a yield of 3% or higher at inception is the goal. If because of market appreciation the yield gets down below 2%, replacing the stock in the portfolio with a higher-yielding stock becomes the objective.

Dividend Growth

Not only is dividend yield important, but dividend growth is also important for long-term performance. Ideally one likes to see stocks growing their dividend in the high single digits to 10% level.

Dividend Payout Ratio

There is a preference to see the payout ratio generally not much higher than 50%. When a company is struggling and paying out too big of a percentage of earnings in dividends, it is a signal that dividend growth could slow or maybe even be cut.

Debt-Equity-Ratio

The debt-equity-ratio is especially important when a company runs into tough economic times. Companies that have a debt/equity ratio of less than 50% are generally preferred. While debt tends to get ignored in up markets, when a recession or major bear market hits the most leveraged companies often get wiped out.

Debt Coverage

How much debt a company has is important, but it’s equally important to observe how much cash the company is generating relative to its total outstanding debt and its ability to meet its interest obligations. Debt service coverage of 3x or higher is attractive.

Return on Capital

Return on capital is a percentage showing how fast a company is growing its business. As a rule, one likes to see a company with a 10% return on capital. Little attention is paid to return on equity since that ratio depends on leverage and is used more by investment bankers.

Current Ratio

Current ratio is the ratio of current assets to current liabilities and is used as a guide to the balance sheet strength of a company and its ability to meet its short-term obligations. Historically, a 2:1 ratio of current assets to current liabilities is a sign that a company is financially strong.

While statistical analysis is important, it is just the start of the research process. It’s also important for the investor to have ideas about where to find good stocks.

In the rest of Section Four we will look at where the best stock picking ideas have come from over the years. As you will see, they came from very diverse places.

11. Book Value

As discussed earlier, Book Value was one of Ben Graham’s recommended price disciplines, along with Price/Earnings and Dividend Yield. While the primary interest is always in P/E, screening for book value is important for some industries.

When looking at companies in certain sectors of the market, book value is a more reliable measure of a stock’s appeal than P/E. Examples would be cyclical companies like air...