One of the things I really like to do is bury myself in market analysis. I really like examining long-term trends in performance and identifying key behavior in the value of stocks.
The inspiration for value analysis
Buying at a low price-to-earnings multiple should be a cakewalk, right? The difficulty with this is that lower price-to-earnings multiples tend to happen on the bottom of an economic cycle.
Morgan Housel states that it’s possible to buy stocks at a low price-to-earnings multiple, and net a pretty significant return based on the below chart.
Source: Motley Fool
Here’s the problem though with this graph. First, it talks about the average annual return following when a stock trades at a low price-to-earnings multiple. This means that you have to time the purchase of a stock when the pricing of it is cheap relative to its growth. The trick to this, however, is that it’s not very easy to pull off. Usually, you can find these cheap stocks when the stock market as a whole is at a discount.
An accurate representation of value investing
Furthermore, I went back and searched for stocks that have had a 0 to 10 price to earnings multiple (10-year average), and also generate 0% to 30% in annual net income growth over the past 10-years. I also included that the market capitalization had to be above $500 million. Below is a screen shot that depicts the results of my screen.
Source: Ycharts Screen & Data
After searching through 4,410 stocks, there were only 18 companies that consistently traded at a low-price-to-earnings multiple, and grew earnings at above average rates over the course of ten years. The list had a ten-year average price-to-earnings multiple of 6.51. Value investors in search of low price-to-earnings stocks would be using this as the primary screening criteria, so I had to include it. The list had a ten-year average annual net income growth rate of 12.51%. The growth rate surpasses the price-to-earnings multiple, which implies that the stocks on the list fall under the classification of “value.”
What makes this list different is that I made an apples-to-apples comparison. Rather than talking about the ten-years after a stock trades at a 10 price-to-earnings multiple. I took a close examination of an average of growth and earnings multiple over ten-years. Both variables had to average over ten-years, meaning that these stocks were trading at a value every year for ten-years. What’s nice about ten-year averages on price-to-earnings is that it lessens the impact on temporary accounting changes that result in inflated or deflated earnings — for example, Yahoo’s! sale of Alibaba.
What it largely indicates is that your odds of finding a long-term value investment is slim to none. Most of the time, stocks with a low price-to-earnings multiple do not generate growth rates above the price-to-earnings multiple. Your odds of success are 18/4,410 or .46% over the course of ten-years. The alternative is to buy a low price-to-earnings multiple stock near a market bottom (but timing market bottoms is a fools game).
Three names from the list that stuck out
The price performance of Annaly Capital Management, Inc. (NYSE:NLY), Compania de Minas Buenaventura SA (ADR) (NYSE:BVN), and Statoil ASA(ADR) (NYSE:STO) vary significantly over ten years.
The three companies have been trading at a value every year for ten-years relative to net income growth. Also, if net income growth is greater than the earnings multiple, it can be assumed that shareholder equity has accumulated.
Annaly Capital Management, Inc. (NYSE:NLY) primarily invests into mortgage backed securities. The company currently trades at a 7.1 price-to-earnings multiple. The problem with investing into the company is its sensitivity to interest rates (higher bond interest rates will lower investment yields). On the upside, it has a 13.56% dividend yield that can be compounded for reasonable earnings. The downside, however, is that the stock could depreciate, which is troublesome. Analysts on a consensus basis anticipate the company to decrease earnings by 4.3% per year over the next five years.