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(More customer reviews)What Works on Wall Street? According to a study of 45 years of stock market data in a book called "What works on Wall Street" by O'Shaughnesy he came to the conclusion that some strategies would have produced greater returns than the S&P 500 whilst others produced less. He tested a range of strategies, re-balancing the strategies annually, with each strategy involving the 50 stocks which met the criteria for inclusion.
The worst strategy that you could have adopted was to buy last year's losers each year. The message is clear - losers carried on being losers. Sometimes the weak beats the strong, but it's not the way to bet your money.
The next ten worst strategies involved buying Companies on high multiples such as high price to sales ratio companies. These companies were generally on high multiples because they were thought to be high growth or sexy companies with lots of potential. They were the then current stock market darlings that investors were prepared to pay up for in order to join in with the latest investment fad or fashion.
As far as the best performing strategies are concerned, he found that the top 6 strategies all involved buying companies with high relative strength in combination with a value factor such as low p/e or low price to sales ratio. These companies were generally on low multiples because they were in out of favour sectors or old economy share that had been overlooked. By combining it with high relative strength (i.e. shares which were rising), these strategies caught those shares whose under-valuation was finally starting to be recognised by the market.
The book found that over long periods, adopting the following rules would have proved to be more profitable than buying the S&P 500: Low price to sales stocks out-perform the higher p/s stocks. Low price to cash flow stocks do better than high p/cfl stocks. Low price to book stocks tend to perform better than high p/b stocks. Other conclusions reached in the book are as follows: Price to sales ratio is the best single value ratio to use for buying market beating stocks. Last years biggest losers are the worst stocks you can buy. Last years earnings gains alone are worthless when determining if a stock is a good investment. You can do four times as well as the S&P 500 by concentrating on large well known stocks with high dividend yields. Relative strength is the only growth variable that consistently beats the market.
Buying Wall Street's current darlings with the highest price to earnings ratios is one of the worst things you can do.
Other lines from the book: Growth investors believe in a Company's potential and think a stock's price will rise with its earnings.
Value investors believe in a company's balance sheet, thinking a stock's price will eventually rise to meet its intrinsic value.
The S&P 500 tracker strategy is a strategy making disciplined bets on large cap companies. This strategy is just one of hundreds of strategies which could exist. For example another strategy might be to measure the performance of all stocks that begin with the letters h,l,m,n, and p. There are many other strategies which have given higher returns in the past than the S&P 500 strategy, some for no logical reason, others with a certain logic. Examples of logical strategies include a disciplined small cap strategy, or a disciplined low price to sales strategy or a disciplined high yield strategy etc. Some of those strategies also performed more consistently than the S&P 500 strategy, ie with less risk.
For example if in the 1950s the editors at Dow Jones had decided to revamp the index buying the 50 stocks with the lowest price to sales ratio, then the Dow Jones Industrial Index would be at 4 times the level of today.
People want to believe the present is different from the past. The price of a stock is still determined by people. As long as people let fear, greed, hope and ignorance cloud their judgement they will continue to mis-price stocks and provide opportunities to those who rigorously use simple time tested strategies to pick stocks. Names change, industries change. Styles come in and out of fashion, but the underlying characteristics that identify a good or bad investment remain the same.
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What Works on Wall Street, Fourth Edition: The Classic Guide to the Best-Performing Investment Strategies of All Time
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