Over the years there have been many studies into how different investment strategies affect your potential returns over the long term. Often these studies involve the selection of companies based on almost childishly simple criteria which ultimately turn out to uncover some hidden truth about market efficiency and the value premium. Since I use these simple screens to make the bulk of my investment decisions, it seems prudent to check that these simple formula still work when applied to the market as a whole. Below is a graph of the returns of all companies* in the main and AIM markets in the UK over the last year, where the company had returns for the last 10 years (as I will be sorting by ROE10 shortly).
Sorted by the size of the returns the returns for over five hundred companies looks like this:
As you can see some did well and some did badly. The average return was 23.7% so this subset of companies strongly outperformed the FTSE 100 and similar indices, but that's not the point of this exercise.
According to much research (not cited here), sorting by P/B (price/book ratio) is likely to show some sort of trend where low P/B stocks outperform the average and definitely outperform high P/B stocks. Sorting (descending) by the estimated P/B from one year ago** produces this:
The trend line does seem to indicate what the literature would have us believe - that on average lower P/B stocks have had better returns in the last year. Breaking the results into five equal groups, the average returns of each group were:
| Group | 1 | 2 | 3 | 4 | 5 |
| Returns % | 18.9 | 22.4 | 25.9 | 24.0 | 27.2 |
Before getting too excited though, remember that low P/B companies tend to be smaller and less liquid, i.e. with a wider spread. I think that the extra returns will be enough to outweigh the spread costs, but spread size is an important factor in low P/B and small cap investing. Something to cover at length another day perhaps along with dividends.
Another point is the spread of returns. In each group some companies did fantastically while others did terribly. Unless you can spot the difference beforehand you need to be sufficiently diversified, otherwise…
