Investing Principles Part IV: Buying Stocks That Have Declined in Price

As our discussion of the Tweedy Browne publication What Has Worked In Investing continues, we’re going to look at the strategy of investing in poorly performing stocks both domestically and globally.

The concept of value investing lives at the core of our stock screening strategies inspired by gurus Benjamin Graham, David Dreman, John Neff and Warren Buffett (who subscribes to the notion that “Price is what you pay; value is what you get.”). Each of these legends has earned fortunes by investing in companies whose stocks were selling on the cheap relative to the underlying values of their businesses.

Such an approach was tested in two different studies described in the Tweedy publication. The first study examined performance results of NYSE listed stocks between 1932 and 1977. The investment results of the worst and best performing stocks were compared to the market index (during periods of the preceding five years) and the study found that the best performers generated average cumulative returns of approximately 6% less than the market index (after 17 months) while the worst performers generated 18% in excess returns over the same period.

The second study examined investment results throughout the world to determine whether they tend to move toward an average return (with large price increases and returns being followed by lower or negative future returns and, conversely, with large price and return declines being followed by positive future returns). The study concluded both to be true and, according to Tweedy, “the authors suggest the desirability throughout the world of investment strategies involving the purchase of shares whose prices have declined significantly.”