Beware 'Cheap' Stocks

Below is a table originally published August 13th, 2007 by Bespoke Investment Group. According to the authors, this screen filtered for "the S&P 500 stocks with less than 25% debt to equity that have the lowest price to book ratios."

click to enlarge

Below is the stock price performance of the above stock screen in the 20 months since it was published on Seeking Alpha.

MTG 42.99 to 2.55 (-94%)

IACI 26.51 to 16.69 (-37%)

CINF 40.37 to 25.43 (-37%)

LSI 6.30 to 3.84 (-39%)

CC 11.50 to 0 (-100%)

ASH 53.65 to 18 (-66%)

MU 12.50 to 5.00 (-60%)

ACE 56.78 to 45.96 (-19%)

TRV 50.00 to 42.53 (-15%)

CB 48.75 to 42.19 (-13%)

ALL 53.20 to 23.42 (-56%)

SYMC 17.72 to 17.27 (-3%)

KG 14.27 to 8.6 (-40%)

HIG 88.35 to 11.18 (-87%)

TLAB 10.25 to 4.91 (-52%)

TMO 52.63 to 37.67 (-28%)

LM 87.34 to 20.20 (-77%)

NVLS 26.51 to 17.88 (-33%)

TMK 60.77 to 32.26 (-47%)

MOLX 24.28 to 16.88 (-30%)

PFG 54.33 to 14.72 (-73%)

AT 67.24 (in takeover agreement at 71.50 prior to publication of this article)

JBL 24.20 to 7.28 (-70%)

X 89.61 to 29.96 (-67%)

TER 15.43 to 5.45 (-65%)

Mean change in price of 24 stocks since August 13th, 2007 = -50%.

S&P 500 August 13th, 2007 = 1453

S&P 500 April 17th 2009 = 870

Change in S&P 500 since August 13th, 2007 = -40%

Conclusion: The S&P 500 outperformed the average stock in the stock screen (for lowest price to book and lowest debt) in the past 14 months by 10%. The best performing stock was Symantec (SYMC, -3%), a software company, and the worst performing stock was Circuit City (CC, -100%), an electronics retailer. Book value as commonly calulated, even when augmented with relatively low debt, was of no downside protection in the decline of the stock market since this article was published.

Comments

[kelm:]

So your conclusion is that buying stocks with low debt and low price to book at the top of a market is no protection for downside risk. It is not however, a predictive indicator that can be used to judge what one should or should not buy at this juncture. In fact, one could argue that in a severe decline cash is the only holding that may be a safe investment and even then we had one money market fund break the buck.

Apr 20 09:01 AM

[Dr. O:]

I'm guessing that most market participants were not aware that they were investing near the market top at the time and were looking for "relative value" and "safety."

Apr 20 09:10 AM