Does value investing work? A recent study of Canadian equity markets indicates that it does.

The study, “Do Value Investors Add Value?” is authored by George Athanassakos, the Ben Graham Chair in Value Investing at the The University of Western Ontario’s Richard Ivey School of Business. It examined equity returns in the Canadian markets from 1985-1999 and 1999-2007, using a methodology that identified “value” stocks as those with the lowest price/earnings and price/book ratios, and “growth” stocks as those with the highest P/E and P/B ratios.

After comparing the performance of the value group vs. the growth group, the study then used a value investing methodology to identify which of the stocks from the value group had a “margin of safety” (assessments of the companies’ net asset value, earnings power, and share price all went into this determination). The entire group of value stocks was considered the “naive” value portfolio, while the subset of stocks that had a margin of safety was considered a “sophisticated” value portfolio — the type of portfolio a value-minded stock-picker might build.

The study’s findings: “We find that a strong and pervasive value premium exists in Canada over our sample period that persists in bull and bear markets and during recessions/recoveries,” Athanassakos writes. “Value stocks, on average, beat growth stocks even when using a very mechanical screening of the search process. Furthermore, this paper demonstrates that value investors do add value, in the sense that their process of selecting truly undervalued stocks, via in-depth security valuation of the possibly undervalued stocks and arriving at their investment decision using the concept of ‘margin of safety’, produces positive excess returns over and above the naive approach of simply selecting low P/E – P/BV ratio stocks.”

What’s more, the study also looked at returns from 2008-09, and found that “despite the fact that over this extended period we had a severe recession and bear market, on average, the sophisticated portfolio still beat the naive value portfolio, consistent with earlier evidence,” Athanassakos writes.

A key  piece of the study is that while the stocks in the sophisticated portfolio — those value stocks that were chosen using the margin-of-safety criteria — fared better than the broader overall group of value stocks, they didn’t on average carry more risk. While the efficient market hypothesis contends that investors can only generate higher returns by taking on more risk, this finding indicates that good stock-picking can, over time, generate market-beating returns without involving more risk.

You can find the full study on the Ben Graham Center for Value Investing’s web site.