ben graham net current asset values a performance update

CFA Institute is collaborating with JSTOR to digitize, preserve and extend access to Financial Analysts Journal.http://www.jstor.orgCFA InstituteBen Graham's Net Current Asset Values: A Performance Update Author(s): Henry R. Oppenheimer Source:Financial Analysts Journal, Vol. 42, No. 6 (Nov. - Dec., 1986), pp. 40-47Published by:CFA InstituteStable URL:http://www.jstor.org/stable/4478980Accessed: 23-03-2015 17:31 UTCYour use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jspJSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of contentin a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship.For more information about JSTOR, please contact [email protected] content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and Conditionsby Henry R. Oppenheimer B enGraham'sN et Current A ssetValues:A PerformanceU pd at e B enGraham's "net asset value"(N A V)crit erioncallsfor buyingsecurit ieswhosepricesare belowt he valueof t he netcurrent asset sof t hecompany.Port foliosformed fromsuchN A V securit ieshadhighermeanret urnst han t he market benchmarksover t he 1970-83 period . Furt hermore,t he 13-yearrisk-ad just ed ret urnsof t he N A V port folioswere significant ly great ert hant hoseof t hebenchmarks.A lt houghind ivid ualN A V port folioperformancesover 30-mont hhold ing period swere wid ely variable,t hese port folios,t oo, out performed t he market . N A V port foliosconsist ingof t hesecurit iesof companiest hat had posit iveearningsbut d idnotpay d ivid end shadhighermeanandrisk-ad just ed ret urnst han t he N A V port foliosof companieswit h posit iveearningst hat d idpayd ivid end s.In ad d it ion,port foliosof securit ies t hat weret he mostund ervalued (as measured by purchasepriceas a percent ageof netassetvalue) t end ed t oout performt he benchmarksby t he wid estmargins. During t he periodexamined ,t he netassetvalue crit erionallowed invest orst oachieveabove-market ret urns. "Italways seemed ,andst ill seems,rid icu- lously simple t osay t hatifone can acquirea d iversifiedgroupof commonst ocksat a price lesst hant heapplicable net currentasset salone-aft erd ed uct ingallprior claims, andcount ing as zerot hefixedandot herasset s-t heresult sshould bequit e sat isfact ory." -B enjamin Graham, TheInt elligent Invest or,1973 EN JA MIN GRA HA M'Snetcurrent assetvalue (N A V) crit erion for st ock select ion is very wellknown.Graham d evelopedandt est edt his crit erionbet ween 1930 and1932, anditwas usedext ensively in t he operat ions oft heGraham-N ewmanCorporat iont hrough 1956. Graham report edt hatissuesselect edon t he basis oft he rule earned , on average, about20 per centper year over a 30-yearperiod . A ft er t hemid -1950s, however,"bargain" issuesbe- camerelat ivelyscarce.Someissuesbecame availableagain d uring t he early 1970s, following t hemarketd eclinesof t helat e1960s, andbe- came abund antaft er t he 1973-74 bear market . This art icle examines t heperformance of securit ies t hat werebargain issuesd uringt he 1970-83 period . Even t hough t he N A V crit erion is t he valuat ion t echnique Grahamis mostfam- ousfor,it hasbeensubjectt orelat ively lit t le research.' Oppenheimer hasprovid edt est sofit s performanceover t he 1949-72 period , buthis t est s (which d onotd emonst rat e consist entprof- it s)are largely confined t od at a prior t o1958. Greenblat t etal. purportt oexamine t he crit erion,but infactexamine asomewhat d ifferentone,int ergrat ing int ot heirscreening mecha- nismacrit erion relat ingfirmP/Eand bondyield s. Furt hermore,t heir risk analysis.is limit - HenryOppenheimeris A ssociat eProfessorofFinanceatt he St at e U niversit yofN ew YorkatB inghamt on.He t hanks GaryG. Schlarbaumfor his helpfulcomment sandaidin execut ingt he researchandCind i Kest erof t he SU N Y- B inghamt onComput erCent erfor comput at ionalassist - ance.Part ialfinancialsupport for t his researchwas provid - edby t heM.I. N eeleySchoolofB usiness,TexasChrist ian U niversit y.1.Foot not esappearatend of art icle. FIN A N CIA LA N A LYSTS JOU RN A L /N OVEMB ER-DECEMB ER1986O40 This content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and Conditionsedandt heir sample size for mostport folios only sat isfact oryfort heperiod December1973 t hrough A ugust1977, a periodofless t han four years.2 Itis in lightoft his lack ofanalysis, andofa recentemphasis on Graham'sprecept s, t hatweund ert ook t his analysis.3 The St ud y Wesimulat edt heinvest ment experience of a hypot het ical invest or whoinvest edin port folios ofcommon st ock usingGraham's N A V crit erion.Tocreat e t heseport folios for each year oft he1970-82period ,wescreened t heent ire December Securit yOwner'sGuid e.For each securit y, wet ook t hesumofall liabilit ies andpre- ferredst ock and subt ract editfrom currentasset s; t his resultwas t hen d ivid edby t he number of commonsharesout st and ing t ogiveN A V. Our invest or boughta securit y ifit s N ovember closing price was nomore t han t wo-t hird s ofit s N A V.4 For t hesefirms, werecord edt he N A V, N ovember closing price, number ofshares out - st and ing, exchange t he firm was t rad edon, andwhet her t he firm hadposit ive earnings or d ivi- d end s over t he prior 12 mont hs. For t he mostpart , we usedst and ardmet hod s ofperformanceevaluat ion. A ll securit ies select - ed from t he December 1970 t hrough December 1972and December1978t hroughDecember 1982 Securit yOwner'sSt ockGuid ewere evaluat - ed .For t heremaining years,weevaluat edall N YSE securit ies as wellasrand om samples ofabout20 t o30 A MEXandOTC securit ies.5Table I summarizes t he d ist ribut ionofsampledsecuri- t ies. Weassumed t hatport folios init ially creat edwere equally weight edon t he d at e ofpurchase, t he lastbusiness d ay ofDecember ofeach year. Thesecurit ies wereheld foreit her12or30 mont hs, d epend ing on t he analysis.6 Afull setofd at a couldnotbe obt ained . Some firms were acquired , ot hers liquid at ed , andst ill ot hers went privat e; for t hesefirms, weusedt hefinalvaluesobt ained bysharehold ers t ocalculat e ret urns. Ot her firms hadt rad ing halt - edby exchanges (includ ing t he N A SD) for various reasons, includ ing filing for bankrupt y andlackof invest orint erest ; fort hesefirms,we used t helastmont hly ret urn for t he mont h in which t rad ing washalt edandnotresumedon anot herexchange(includ ingt heover-t he- count er market ). This t reat ment t acit ly assumedt he invest or liquid at edhis int erestin t he firm att he lastt rad edprice wecouldobt ain from t he st and ardsources list edabove.7 For each analysis, we comparedmean mont h- ly ret urns for t heN A V port folios wit hvarious marketbenchmarks. Thesemeanret urn comparisons provid e an ind icat ion ofhow an inves- t or mighthave faredfrom a wealt h perspect ive vis-a-visbenchmarks heor shemightconsid er relevant . Securit y ret urns werealsoevaluat edusing t he following mod el: Rpt- Rft= ap + /p(Rmt- Rft ) + ept ,(1) where Rpt = t hemont ht (t =1,...,T)ret urn earned byaport folio of securit ies meet ing t he N A V crit erion purchasedin mont h 0 andheldT mont hs; Rft=t he "risk-free"(T-bill)rat e ofret urn in mont h t ; Rmt= t he rat e ofret urn on t he marketbench- mark used ; ept = an errort erm assumedt ohave expect - edvalue ofzeroandbe serially uncor- relat ed ; fPP=cov (Rpt , Rmt ) /ao(Rmt ) or t heport folio's risk relat ive t ot he market ;andap = t he measure ofmont hly abnormalper- formance for t he port folios evaluat ed . Equat ion (1) ind icat es t hatrealizedport folioret urn in excessof t herisk-free rat e isa linear funct ion oft hree t erms-apremium for accept - ing risk (namely t he prod uctoft he port foliorisk andt he market 'sret urn in excess oft he risk-free rat e), a rand om errort erm (wit h expect edret urn ofzero) andan est imat e ofsecurit y performance not account ed forbyeit herport folioriskor market ret urn. This lastparamet er, axp,provid es TableIDist ribut ionof Sampled N et A sset Valuesby Exchange YearN YSEA MEXOTCTot al 19708111332 19711131226 197227918 197324252473 197425342584 197523302376 197611272462 19776242454 19789463489 19792282151 19803161433 19814121329 1982231318 Tot als120276249645 FIN A N CIA LA N A LYSTS JOU RN A L/ N OVEMB ER-DECEMB ER1986C41 This content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and Conditionsa d irectest imat e of t heselect ivit y of t heN A V crit erion.8 We performedseveral ad d it ional t est s t od e- t ermine ifany evid ence ofselect ive abilit y mightact ually representa small-firm effect . First , we analyzedeach exchange's firms separat ely, provid ingseparat ecomparisonswit ht heCRSPvalue-weight edind ex, t he exchange benchmark andasmall-firm ind ex.Second ,givent hatre- centevid ence ind icat es t hatmuch oft he small- firm effectoccurs in January,we analyzedt hese port folios assumingpurchaseonJanuary 31, t husomit t ingpossiblehighJanuary ret urns. Finally, wecomparedt het est ed port folios d i- rect ly wit hport folios of similar marketcapit alizat ion. Result s Table II summarizes result sfor t heent ire13- yearperiod of t hest ud y.PanelAcompares ret urns ofN A V port folios wit h ret urns on bot h t he N YSE-A MEXvalue-weight edind ex andt he small-firm ind ex.Weassumed allsecurit ies meet ingt heN A Vcrit erion inDecember 1970 were purchasedon December 31, 1970, heldfor one year andreplacedon December 31, 1971by t hosemeet ing t hecrit erion inDecember 1971. Thisproced ure wasfollowed forsubsequentyears. Thus t hese result s cover t he periodfrom December 31, 1970 t hrough December 31, 1983. Panel Brepresent s t he13-year performance ofeachexchange'ssecurit iesversust heN YSE- A MEXind ex, an exchange benchmark andt he small-firmind ex.9 Panel C present s result s for fourconsecut ivesubperiod s of approximat ely equal lengt h. During t he 1970-83 period , t he mean mont h- ly ret urn ofN A V port folios was2.45 per cent . B y cont rast , t he mean mont hly ret urns for t he N YSE-A MEXandsmall firm ind exes were 0.96 and 1.75percent ,respect ively. Toput t hese result s in a form more meaningful t oan inves- t or, $10,000 invest ed int heN A Vport folioon December31,1970would havegrownt oTableIIPerformanceMeasuresfort he13-Year Period a MeanRet urnsRisk-A d just ed Measures Rp.R.ta t o) p Rmta~~~~~~~~~~~~ (%)(%)(%)t (a)P ,B t (pi)bR Panel A : Ent ire Sample vs.N YSE-A MEX Ind ex2.450.961.462.60c 1.109.23"0.356 vs.Small-Firm Ind ex2.451.750.671.72b1.0318.70d 0.694 Panel B : Securit ies in Each Exchangevs.Various B enchmarks N YSE vs.N YSE-A MEX Ind ex0.690.96-0.40-0.671.4111.15d 0.447 N YSEvs.S & P5000.560.470.150.251.4210.30d 0.408 N YSE vs.Small-Firm Ind ex0.691.75-1.22-2.53c 1.1516.92d 0.650 A MEX vs.N YSE-A MEX Ind ex2.360.961.382.04c 1.077.48d 0.266 A MEX vs.A MEX Ind ex2.261.171.101.80b0.9910.33d 0.409 A MEX vs.Small-FirmInd ex2.361.750.511.031.1015.92d 0.622 OTC vs.N YSE-A MEX Ind ex2.870.961.923.28d 0.987.91d 0.289 OTC vs.N A SDA Q2.660.871.783.48d 1.0411.53d 0.463 OTC vs.Small-Firm Ind ex2.871.751.232.60c 0.9013.58d 0.545 Panel C: Three-YearPeriod sa vs.N YSE-A MEX Ind ex 1970-19720.050.38-0.30-0.261.585.14d 0.437 1973-19753.580.822.813.79d 1.349.09d 0.489 1976-19782.410.761.652.11c 1.015.18d 0.441 1979-19823.421.642.032.18c 0.653.38d 0.199 vs.Small-Firm Ind ex 1970-19720.05-0.250.891.201.1410.86"0.581 1973-19753.582.150.781.96b1.1423.41"0.862 1976-19782.412.490.180.550.8119.09d 0.811 1979-19823.422.371.261.68b0.866.80d 0.501 a. Purchaseon December31 ofd esignat edyear. b. Significant at10 per centlevel. c. Significant at5 per centlevel. d . Significant at1 per centlevel. FIN A N CIA LA N A LYSTSJOU RN A L/ N OVEMB ER-DECEMB ER1986 O42 This content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and Conditions$254,973 (wit hmont hly compound ing) byDe- cember 31, 1983. The comparablefigures for t he N YSE-A MEXand small-firmind exesare $37,296 and$101,992, respect ively. Comparing t he ret urns oft he N A V securit ies on any exchange wit h t he exchange benchmark, t he N YSE-A MEXind ex or t he small-firmind ex yield s similar result s. Wit h t he except ion oft he N YSE securit ies,t heN A Vport foliosout performedt he benchmarksby relat ively large mar- gins.It should benot ed ,however,t hat t he result sof PanelCind icat et hat t heseresult s were notst able over t ime. Over t he13-year period , t he N A V port folios onaverageout performedt hecomprehensive N YSE-A MEXind ex byapproximat ely 1.46 per cent permont h(19percent peryear)aft er ad just ing for risk. When comparedt ot he small- firm ind ex, t hese port folios earned , on average, an excess ret urn ofapproximat ely0.67 per centper mont h (8 per centper year).10 Several int erest ing result semergefrom t he risk-ad just ed result s in Panel BofTable II. First , port folios ofN YSE securit ies d idnotearn excess ret urns whencomparedwit hanyof t het hree benchmarks used ."Second ,bot ht heA MEX and OTC port folios out performedt heind exes by wid emargins. Third , perhaps surprisingly, t he syst emat icrisk levels were highestfor N YSE securit ies andlowest for OTC securit ies. Final- ly,t heresult sd o not reflect sizeeffect s; al- t hough,onaverage,t heN YSE firms aret he largest , t he OTC firms are only slight ly smaller, wit h t he A MEXfirms being much smaller t han eit her t he N YSE or OTC firms. Table II present s a pict ure ofaggregat e N A V port folioperformance over t he13-year period . Ont hewhole,performance, whenmeasuredfrom anyperspect ive, would havebeenquit e sat isfact ory. Thirt y-Mont h Hold ingPeriod s TableIIIpresent st heresult swhenN A V securit ies are purchasedoneach December 31 TableIIIPerformanceMeasuresfor 30-Mont hHold ingPeriod s Terminal Wealt h ofMean Ret urns$10,000Risk-A d just ed Measures Purchase Rpt Rmt N A VMarket a Dat ea(%)(%)IssuesInd ex(%)t (a)bpt (p)bR2 Panel A : vs.N YSE-A MEXValue-Weight edInd ex 19700.470.56$19,557$11,639-0.21-0.191.644.94d 0.466 1971-0.08-0.478,5848,5520.620.371.232.69c 0.205 19721.36-0.3111,5568,5991.810.771.143.07d 0.252 19733.600.7824,44111,9302.781.691.194.58d 0.429 19745.371.8842,58116,9932.481.88b1.706.01d 0.563 19753.700.8828,18012,7262.723.31d 1.235.64d 0.532 19762.750.5821,53311,6242.173.07d 1.055.82d 0.547 19772.641.3619,73614,4731.061.201.377.73d 0.681 19782.861.7822,13116,4461.171.430.905.17d 0.489 19792.160.9418,17612,7671.191.360.734.14d 0.380 19803.881.6130,22015,6352.533.11d 0.613.55d 0.311 1981e3.531.7321,92314,7982.291.650.481.540.098 1982'5.851.7718,93712,2974.111.350.970.930.089 Panel B : vs.Ibbot son andSinquefieldSmall-FirmInd ex 19700.47-0.27$19,557$8,7780.881.381.2216.34d 0.821 1971-0.08-0.988,5846,9581.030.831.095.99d 0.562 19721.360.1411,5569,3101.320.761.226.21d 0.579 19733.602.1724,44117,1511.111.341.1913.08d 0.859 19745.373.7442,58127,8592.221.91b1.4711.28d 0.927 19753.703.3428,18025,3050.571.460.9316.89d 0.911 19762.752.7021,53319,6740.581.340.7512.26d 0.843 19772.642.4219,73618,4230.170.140.846.73d 0.819 19782.863.3222,13124,959-0.11-0.110.725.39d 0.744 19792.161.5518,17614,9660.731.120.777.43d 0.664 19803.881.6530,22021,1541.542.49c 0.827.00d 0.636 1981e3.532.5521,92317,8771.020.910.984.37d 0.465 1982"5.852.9218,93713,9671.680.761.563.48d 0.548 a. Purchaseon December31 ofd esignat edyear. b. Significant at10 per centlevel. c. Significant at5 per centlevel. d . Significant at1 per centlevel. e. Hold ing periodof24 mont hs. f. Hold ing periodof12 mont hs. FIN A N CIA LA N A LYSTSJOU RN A L/ N OVEMB ER-DECEMB ER1986 D43 This content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and ConditionsTableIVYearly N A VRet urnsvs.Small-Firm Ind exand Reinganum'sMV1 Port folioPanelA :Ret urnComparisons Small- Firm N A VInd exMV1 Year St art ing December31Ret urnRet urnRet urn 197021.3%16.5%27.8% 197129.04.49.8 1972-43.0-30.9-38.1 1973-19.0-20.0-12.7 1974127.152.880.9 197558.457.457.0 197635.425.420.6 197723.123.533.5 197832.143.543.9 197936.739.327.6 198025.513.9N .A . 198139.428.0N .A . 198289.439.7N .A . 13-Year TerminalWealt h$254,973$101,992N .A .* 13-Year A nnualGeomet ricMeanRet urn28.2%19.6%N .A .* 1970-74TerminalWealt h$16,148$10,273$13,718 5-Year A nnualGeomet ric MeanRet urn10.1%0.5%6.5% 1975-78TerminalWealt h$34,877$34,980$36,374 4-Year A nnualGeomet ric MeanRet urn36.7%36.8%38.1% 1979-82TerminalWealt h$45,295$28,371N .A . 4-Year A nnualGeomet ric MeanRet urn45.9%29.8%N .A . PanelB : RiskComparisons 1970-79 HighB et a1.92 MeanB et a1.271.58 LowB et a0.52 1970-74MeanB et a vs.N YSE-A MEX Ind ex1.39 vs.Small-Firm Ind ex1.27 1975-78MeanB et a vs.N YSE-A MEX Ind ex1.11 vs.Small-Firm Ind ex0.79 1979-82MeanB et a vs.N YSE-A MEX Ind ex0.70 vs.Small-Firm Ind ex1.03 * MV1ret urnsendatt he endoft he year beginning 12/31/79.The 1970-79t erminalwealt h andgeomet ricmean ret urnsfor t he t hree port folios are, in ord er:($76,950;22.6%),($50,257;17.5%)and($63,667;20.3%). andheld for 30 mont hs.12This t able provid es comparisons wit h bot h t he N YSE-A MEXind ex (Panel A ) andt he small-firmind ex (Panel B ). The result s largely parallel t hoseof Table II. From aret urn(and wealt h)perspect ive,t he ad vant age oft he N A V port folios over t he mar- ketind exes is consist ent ly pronounced . Similar- ly,t herisk-ad just edexcessret urns are invari- ably large-11oft he 13 excess ret urns obt ainedin comparisons wit h t he N YSE-A MEXind ex are great er t han1percent mont hly(over 12 per cent annually), and 11 of t he13 comparisons wit ht hesmall-firm ind exare great er t han 0.7 percent mont hly(over8percent annually). However, few oft hese excess ret urns are st at is- t ically significant . Firm Sizeand Ret urn A llanalysespresent ed sofar assumeaDe- cember 31purchase d at e.Manyst ud ieshave not ed t hat ,ingeneral,st ocksof smallfirms t rad e infrequent ly. Thus at t empt edpurchase oft hesefirms onDecember 31 may not resultin realizedpurchase unt ilsomet ime inJanuary. Furt hermore,Keim find s t hat50 per centoft he excessret urnsfrominvest inginsmallfirm st ocksoccurs inJanuary and ,ind eed ,25per centoccurs d uring t he firstfive t rad ing d ays in January.13 Thus onemightlogically wond er ift he ret urns report edt hus far are realizable, or ift heyaremerelyselect ivit yeffect semanat ing from t hesmall-firm effect s.There areseveral ways ofad d ressing t his issue. FIN A N CIA LA N A LYSTS JOU RN A L/N OVEMB ER-DECEMB ER1986D44 This content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and ConditionsTableVPerformanceMeasuresConsid eringEarningsand Divid end sa Mean Ret urnsRisk-A d just ed Measures Rmt at (a)b Rpt(%)(%)(%)pt (p)bR2 PanelA : Ent ireSample vs.N YSE-A MEX Ind ex2.450.961.462.60c 1.109.230.356 vs.Small-Firm Ind ex2.451.750.671.72b1.0318.700.694 PanelB : Posit iveEarningsDuringPriorYear vs.N YSE-A MEX Ind ex2.410.961.432.881.059.980.393 vs.Small-Firm Ind ex2.411.750.752.02c 0.9317.78d 0.673 PanelC: N egat iveEarningsDuringPriorYear vs.N YSE-A MEX Ind ex2.610.961.581.97b1.227.17d 0.250 vs.Small-Firm Ind ex2.611.750.620.991.2213.94d 0.558 PanelD:Posit iveEarningsand Divid end sDuringPriorYear vs.N YSE-A MEX Ind ex2.010.961.082.47c 0.909.670.378 vs.Small-Firm Ind ex2.011.750.501.480.7916.66d 0.643 PanelE: Posit iveEarningsand N o Divid end sDuringPrior Year vs.N YSE-A MEX Ind ex2.880.961.842.54c 1.288.380.313 vs.Small-Firm Ind ex2.881.750.991.66b1.1413.61d 0.546 a. A ll panels for 13 years. b. Significant at10 per centlevel. c. Significant at5 per centlevel. d . Significant at1 per centlevel. First , wecould assumet hesecurit ies were purchasedinmid -December. U nlesst hemid - December t oDecember 31 average price change wassignificant ly d ifferentfromzero,t here- t urns present edt husfar were realizable if you assumeit t akesno moret hant wo weekst opurchase securit ies t hatwere t hinly t rad ed .'4 Second ,separat e regressions (comparablet ot hose ofTable III)wit h assumedpurchase d at e of January 31couldbeperformed . We d id soand found t hat t hemeanand excessret urns est imat edfrom t hese regressions, while consis- t ent ly smaller t han t hosereport edin Table III, st illsupport ed t heconclusiont hat t heN A V crit erionprovid edsat isfact oryperformance.15 Third , inTable IV weprovid e yearly mean ret urn comparisons of t heN A V port folios andt he small-firmind ex. These result s show t hat , in amajorit y of t heyears,t heN A Vport folios out performedt he small-firmind ex. The result s of t hist ablesupport t heconclusiont hat t he N A V port folios were, on average, aooutas risky ast hesmall-firm ind exand provid ed significant ly higher ret urns. Fourt h, itis possible t hatt he securit ies in t he N A Vport folios are,onaverage, evensmaller t han t hose in t he small-firmport folio. Table IV comparest heret urnsof t heN A Vport folios wit h t hose ofReinganum's smallestmarket value port folio(MV1).16 In t erms ofsize ofsecuri- t ies,t heseport foliosarecomparable.Rein- ganum report s amed ian capit alizat ion for his 18-yearperiodof$4.7 million. The med ian capi- t alizat ion of t he10 N A V port folios is$4.1 million. While we d onotknow t he mean capit aliza- t ion of t he MV1 port folio, itisclearly less t han t hatof t heN A Vport folios ($10.7 million), be- cause weknow t hatt he med ian value ofRein- ganum'sMV2port folio (hissecond -smallestport folio) is$10.8 million.Ont heot her hand , Reinganum report sameanbet a(versust he N YSE-A MEXvalue-weight edind ex) of1.58; t he mean oft he 10 N A V port folios' est imat edbet as is 1.22. Itwouldappear t hatt he N A V port folios achieveda slight ly higher ret urn (22.6 vs.20.3 per cent ) t han t heMV1 port folios whilebeing consid erablyless risky. Closeexaminat ion of Tables II,III and IV suggest st hat t hisperiod canbed ivid ed int ot hree d ist inctperiod s-1970-74,whenN A V is- suesout performedt herelevant benchmarks; 1975-78, when noad vant age exist ed ; and1979- 82, whenagain t heN A Vissuesout performedt he benchmarks. Table IV clarifiest his d ivision. The t able ind icat es t hat , d uring 1970-74, t he N A V port foliohadconsid erably higher ret urns t han bot ht hesmall-firm and MV1 port folios, whilehavingsomewhat higherriskt hant he small-firmport folio(a bet a of1.27 as measuredagainstt hatport folio) andsomewhatlower risk FIN A N CIA LA N A LYSTS JOU RN A L/N OVEMB ER-DECEMB ER1986E45 This content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and Conditionst han t he MV1 port folio(a bet a of1.39 relat ive t ot he N YSE-A MEXind ex, while MV1 hada bet a of1.58 relat ive t oit ). Incont rast , d uringt he1975-78 period ,t he ret urns of t het hreeport folios wereid ent ical. However, t he N A V port foliohada bet a relat ive t ot hesmall firm ind exof only0.79,whileit s bet a relat ive t ot he N YSE-A MEXind ex was 1.11 (andMV1's was1.58). Finally, d uring t he 1979-82 period , t he ret urn oft he N A V port foliowas far great ert han t hatoft hesmall-firm ind ex,whilet heport foliowas approximat elyas risky as t he ind ex. Thus, d uring all t hree period s, t he N A V port folios provid - edexcess ret urns aft er explicitconsid erat ion ofbot h risk andsize. DoEarnings or Divid end sMat t er? Graham frequent ly provid ed hisN A Vad vice wit h t he caveatt hatitwas bestt oselectsecuri- t iest hathad posit iveearnings and t hatwere paying a d ivid end . Tot hatend , wed ivid edt he sampleint o t wo groups-agroupt hat hadposit iveearnings overt hepast year (approximat elyt wo-t hird sof t hefirms) and agroup operat ing ata loss.Panels BandC ofTable V presentt heperformances of t hesegroups. N oclear-cutpat t ern emerges from an examinat ion oft hese panels. Ifanyt hing, firms operat ing ata lossseemt ohaveslight ly higher ret urns andrisk t han firms wit h posit ive earnings. We next asked if t hed ivid end crit erion im- provedperformance. Panels D andE ofTable V present t heseresult s.Firmshavingposit ive earningsand payingad ivid end provid ed a lowermean ret urn t han port folios offirms wit h posit ive earnings not paying a d ivid end .They alsohadalower syst emat icrisk. Finally, t heir risk-ad just ed excess ret urns were notas high as t hoseof t heport folioof firmswit hposit ive earnings but not payingd ivid end s.Choosing onlyfirms t hathaveearnings and payad ivi- d endd oes nothelp t he invest or. 17 Degree ofU nd ervaluat ion andPerformance The N A V crit erionind icat es t hatt he invest or is t opurchase allsecurit ies wit haprice t hatis t wo-t hird s or lessofN A V. Aquest ion ofsome int erestis whet her t he d egree ofund ervaluat ion is relat edt osubsequentperformance.Toexam- inet his,wecalculat edforeachsecurit y purchase price as a percent age ofN A V. Each year, we d ivid edt he populat ion int oquint iles accord - ing t ot his variable andanalyzedmean ret urns aswellasrisk-ad just edperformance. There- sult s are present edin Table VI. The conclusion isclear-cut . Ret urns andex- cessret urns can berank-ord ered , wit hsecuri- t ieshavingt hesmallest purchasepriceasa percent age ofnetassetvalue having t he largestret urns. Itappears t hatd egree of und ervalua- t ion isimport ant : The d ifference in bot h mean ret urn and risk-ad just edret urn bet weenquin- t iles 1 and5 is over 10 per centper year.' 8 a TableVIN A VPerformancebyQuint ilesof PurchasePrice asaPercent ageof N et A sset Value MeanRet urnsRisk-A d just ed Measures Rpt Rmt at (a)a Quint ile(%)(%)(%)(%)3t (aR 2 PanelA : vs.N YSE-A MEXInd ex 12.950.961.922.32b1.236.96c 0.239 22.660.961.642.20b1.177.39c 0.262 32.510.961.592.09b0.895.56c 0.167 42.140.961.171.631.077.08c 0.246 51.880.960.861.541.189.96c 0.392 Sample2.450.961.462.60b1.109.23c 0.356 PanelB : vs.Ibbot sonand Sinquefield Small-FirmInd ex 12.951.751.011.471.1712.11c 0.488 22.661.750.831.311.0812.14c 0.489 32.511.750.801.270.9710.94c 0.436 42.141.750.440.710.9711.000.440 51.881.750.110.261.0216.880.649 Sample2.451.750.671.72a1.0318.70c 0.694 a. Significant at10 per centlevel. b. Significant at5 per centlevel. c. Significant at1 per centlevel. FIN A N CIA LA N A LYSTS JOU RN A L/N OVEMB ER-DECEMB ER1986G46 This content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and ConditionsFoot not es 1.See for example P. B luest ein, "B enGraham'sLastWill andTest ament ," Forbes,A ugust1, 1977. 2.See H. Oppenheimer, CommonSt ockSelect ion.A n A nalysisofB enjaminGraham's'Int elligent Invest or" A pproach(A nn A rbor, MI: U MI Research Press, 1981) andJ. Greenblat t , R.Pzena and B . N eu- berg,"Howt heSmall Invest orCanB eat t he Market ," JournalofPort folioManagement ,Sum- mer, 1981, pp.48-52. 3.Seefor example W.B uffet , "U pt heInefficientMarket !GrahamandDod dis A live andWell in Wall St reet ," B arrons,February25, 1985, pp.11, 37-40. 4.ForOTCsecurit ies,t hebid pricewasusedt hroughout .Weknowof no ot hercommonly available source t hatprovid esamore compre- hensivelist ingof publicly available firms. The St ockGuid einclud es all N YSEandA MEXfirms as well as a large number offirms t rad edover-t he- count er, on regional exchanges andon t he Cana- d ian exchanges. Itisunclear whet her t heSt ock Guid e syst emat ically exclud esanyset of firms likelyt o meet t hecrit erion t hat anA merican invest or wouldlikely look atandt rad e t hrough a broker. Thus itisreasonable t obelieve t hatt he t est s present edare oft he crit erionrat hert han t he d at a source. Finally, TheSt ockOwner'sGuid ewas usually receivedby December 10, in t he libraryin which t he screening was performed , sot his pro- ced ure wouldbe feasible for an invest or. Finally, itshouldbe not edt hatt his screening process was alsoperformedin1983, butonly four securit ies mett he crit erion. These were notanalyzed . 5.N YSE securit y ret urns wereobt ainedfrom t he CRSPt apes, while some A MEXandOTCsecurit y ret urns wereobt ainedfrom t hePDE t ape.The remaining securit y pricesforA MEX and OTC firms had t obehand -gat heredfromst and ardsources. Tokeep t his projectofmanagable size, only20t o30securit ies (every t hirdorfourt h A MEXor OTC N A V on each oft hese list s) were used . 6.Graham, invarioused it ionsof The Int elligentInvest or,suggest ed hold ingt heseissuesupt o2-1/2 years was appropriat e. 7.Thisproced urelikelybiasest heperformance measures oft he nextsect ion d ownward .Only t wofirmst hat filed forbankrupt cy act uallywentbankruptd uringt heperiod examined .Ot hers t hatfiledfor Chapt er XI (such as Int erst at e De- part mentSt ores) lat er eit her emergedfrom bankrupt y (Int erst at e St ores became Toys'R U s)or were acquired , in bot h cases invariablybecoming far more valuable t han t helastprice weused . Those firms nolonger list edin st and ardsources invariablywere eit her acquired , wentprivat e or hadsubsequentyearly price ranges inMood y's manuals higher t han t he lastprice weused . 8.This met hodofanalysis was firstint rod ucedby M. Jensen in "The PerformanceofMut ual Fund s int he Period1945-1964," TheJournalofFinance, May 1968, pp.389-416. 9.Pleasenot et hat inallcomparisons wit ht he exchange benchmarks ret urns wit hout d ivid end s areused for bot ht hesecurit y ret urn and t he benchmarkret urn. The small-firmind ex was ob- t ainedfrom R.Ibbot son, "St ocks, B ond s,B ills and Inflat ion 1984 Yearbook" (R.G.Ibbot son A ssociat es, Inc.; Chicago, 1984). 10.The securit iesevaluat edhave relat ivelyconserva- t ivebalance sheet s,wit hverylit t lelong-t erm d ebt .From t hat perspect ive,t heest imat e risk levels are relat ively high; average syst emat icrisk of t he port folios versust heN YSE-A MEXind ex was 1.10, while relat ive syst emat icrisk versus t he small-firmind ex was1.03. 11.However, some care shouldbe exercised in int er- pret ing t he result s for port folios ofN YSE securi- t ies.Inseveralyearsit would not havebeen possiblet o purchase ad iversifiedport folioofN YSEsecurit ies (see Table I). If, for example, t he analysis of N YSE securit ies isconfinedt oonly t hoseyearswhen10ormoresecurit ies were available (1973-76 inclusive), much d ifferentre- sult s emerge: RPRma t (a) 3 t (3R2 vs.N YSE-A MEX Ind ex2.9740.5342.432.41**1.407.30`'0.537 vs.S&P5002.7520.0772.822.63**1.346.52"'*0.481 vs.Small-firmInd ex2.9742.1090.520.831.2215.01**'0.830 12.A t t het imet heaut hor performedt hest ud y, cert ain d at a for period s subsequentt oDecember 1983 werenot available. Consequent ly, for t he December 1981 and1982port folios, hold ing period s of24 and12 mont hs were analyzed . 13.See D. Keim, "Size Relat edA nomalies andSt ock Ret urnSeasonalit y-Furt herEmpiricalEvi- d ence,"Journal of Financial Economics,March 1983, pp.3-32. 14.Itshouldbe not edt hatt he mean price change for t he 645 securit ies d uring each appropriat ewhole mont h ofDecember was only 0.35 per cent . 15.Theset ables are available uponrequestt ot he aut hor. 16.SeeM.Reinganum, "Port folioSt rat egies B asedonMarketCapit alizat ion," Journal of Port folioManagement ,Wint er 1983, pp.29-36. 17.A nanalysis of t he13 port folios wasalsoper- formed . The conclusions aboutearnings andd ivi- d end s alsoholdfor t hem. 18.This is nota size effect . The correlat ionbet ween size andprice as a percent age ofN A V is - 0.03, which is notsignificantatt he 10 per centlevel. FIN A N CIA LA N A LYSTSJOU RN A L/ N OVEMB ER-DECEMB ER1986 O47 This content downloaded from 167.206.79.231 on Mon, 23 Mar 2015 17:31:12 UTCAll use subject to JSTOR Terms and Conditions