Gavekal Capital: The Most Expensive Stocks Have Surprisingly Outperformed

Monday, October 20, 2014

The Most Expensive Stocks Have Surprisingly Outperformed

One of the ways we like to dissect equity performance is by taking a valuation factor, such as the price-to-book ratio, and analyzing how the performance of the lowest (i.e. cheapest) price-to-book stocks have performed relative to the performance of the highest (i.e. most expensive) price-to-book stocks. In the table below, we place all 1600 MSCI World Index stocks into 10 different deciles based on its price-to-book value. The first decile is lowest 10% price-to-book stocks and the 10th decile is the highest 10% price-to-book stocks.

Judging by the R-squared value in the bottom row of the table, stock performance has been highly correlated to price-to-book ratio over all time frames over the past year. Over the past month, the cheapest stocks have fallen by 11% on average compared to the most expensive stocks which have only dropped by 5%. The returns over the last year are even wider. The cheapest stocks have dropped by over 14% while the most expensive stocks have increased by 10%.

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We also see that stocks have performed inverse to its dividend yield level. The stocks with the highest dividend yield have fallen by nearly 9% over the past year. The stocks with the lowest dividend yield have increased by 3.7% over the past year. Looking ahead, it would be surprising if the most expensive and lowest yielding stocks continue to impressively outperform especially as valuation levels remain near record highs.

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