Customer Reviews

Trouncing the Dow: A Value-Based Method for Making Huge Profits in the Stock Market

5 star:		(28)
4 star:		(7)
3 star:		(5)
2 star:		(5)
1 star:		(2)

 

 

The 1990's have brought a striking popularity in books that promise outsize returns based on simple formulas. The most obvious example of the genre is the Dow Dogs strategy. Made popular by Michael O'Higgins and Jim O'Shaughnessy, among others, underperformance in recent years has done little to dampen investor enthusiasm.

Kenneth Lee's Trouncing The Dow offers a new twist on betting the undervalued Dow stocks theory. Employing a methodology he dubs benchmark investing, Lee seeks to establish price ranges using historical return on equity and price/book value figures. Once established these price ranges are used to establish concrete reference points the investor can use to consistently focus on undervalued stocks. The book has tables of the calculations from 1973-96, allowing those so inclined to compare current valuations with past Dow results under most market conditions. The process also forces the reader to dig into a company's fundamentals and get a feel for how it has been priced in the past.

The appeal here is obvious. A concise method for divining value on a select group of non-volatile stocks where information is readily available. (Lee suggests using The Value Line Investment Survey). The mechanical process eliminates emotion from the equation, allowing the reader to use history as a guide when uncertainty has gripped the market. The fact that Lee stresses low turnover, eschews market timing, and adheres to popular value tenets puts the ideas here on the same wavelength as studies produced recently in books by Jeremy Siegel and Jim O'Shaughnessy. Personally however, when I see strategies based on Dow stocks I tend to want to see computer studies based on similar stocks. I want to see large samples. They give the picture texture and background, they help point out any possible flaws or reasons for concern. Back testing has its limitations. Early on Lee states he originally developed the formula employing the Value Line universe on a computer. In fact, the current configuration of Value Line's electronic product makes Lee's process relatively easy to implement on a broad scale. To include summaries of the results of that data would have added considerable weight to his argument.

It seems to me that the real question here is whether anomalies pointed out here and popularized by O'Higgins and others will continue to outperform. Indeed, many of the ideas here overlap with popular titles of the last few years. Is the Wall Street establishment so short-term focused that long-term value plays based on simple rules offer an easy short cut? Though many would like to deny it, there is enough efficiency in the United States equity markets to make outperformance a relatively difficult task. Though the idea of "beating the experts" without complex strategies makes a cute media story, it continues to be a tall order.

In Trouncing The Dow, Lee makes the case it can be done. The book is a quick read and offers a formula that anyone can employ to make up his or her own mind.

Reading TTD, after reading other books on 'Value Investing' I actually found a strategy that I could use. I have been a student of finance over 30 years and have read other books, and this book gave me 'the tools' to evaluate a companies a companies potential.

I can't say that this book will teach you everything, but it does a very good job of teaching you the basics. Though 'value investing' is not in favor for the current times, I do believe it is the most sensible approach to evaluate a company, and over the long term will prove to be a better approach then chasing the 'whats hot on wall street' method.

If you are a conservative invester, read this book. If you are an aggressive investor, looking for returns of 30% or more(every year), good luck.

Despite the gimmicky title that kept me from buying it when it first came out last year, I now consider Trouncing the Dow to be one of the best investment books ever written for the serious long-term investor. I'd put it right up there with classics like The Intelligent Investor, Stocks for the Long Run, A Random Walk Down Wall Street, One up on Wall Street, The Warren Buffett Way, Reminisces of a Stock Operator, Supermoney, and Against the Gods.

Kenneth Lee presents his version of value/contrarian investing in this excellent book, which is filled with insight from some of the greatest investors of all time. His valuation model is easy to apply and takes the emotion out of investing. He preaches classic ideas such as margin of safety and buying fallen stocks. This book is 'the book' for anyone who wants to maximize return while minimizing risk. He also recommends additional books on investment that should be included in any serious investors' library.

As some other reviews of this book state, there are NO perfect mathematical formulae for selecting investments. No formula can consistently anticipate all of the myriad changes that can affect a particular issue in the highly fluid, dynamic universe of investments. All valuation formulae are simplistic constructs which are used in the place of an elusive, magical crystal ball to derive either the absolute or relative worth of financial instruments. And all such constructs must be based upon assumptions (which are subject to all sorts of errors)- all of them!

Perhaps the most widely-used financial formulae today are based on some variant of discounted cash flow (DCF). But DCF requires selection of an appropriate discount rate, a forecast of future cash flows, and some kind of wild-eyed guess as to the investment's terminal value. Calculations which substitute earnings for cash flow are hopelessly flawed from the outset! Any calculation which uses a forecast is probably "in over its head" before any processing is done.

Since we cannot find the perfect formula which will yield calculations of 100% certainty, perhaps we should base our investment philosophy on skilled analyses of financial statements. However, financial statements are also built upon (possibly flawed or outdated) assumptions and conventions, and are hopelessly backward-looking while markets are always forward-looking. Financial information is too stale and is often inaccurate (vide ENRON or WorldCom, etc.).

Maybe following news releases would be better. However, because markets are discounting mechanisms, most of the financially important events are already incorporated into the market price before the news is released. Try an experiment: record the breaking news stories, both positive and negative, on any financial news network and see how well the companies and their stock prices perform 30, 90, 180, and 365 days after the news release. On many of the positive stories, you will find that the stock price will sell no, or only marginally, higher on the day of the release, and thereafter. You will often find the converse for negative news releases. Buying on positive- or selling on negative- releases is not likely the way to make consistent profits in the financial markets.

Then there is technical analysis, which is often not very technical at all. Last week, a major bank group fired the entire staff from its 45 year-old technical analysis department because the bank's management could not find added value to its overall operations from this department. However, Andrew Lo, et. al., from the Massachusetts Institute of Technology, performed a study on technical analysis over a 30 year period and found that certain indicators provided an incremental benefit to investment returns over the period studied. There may be some utility to be mined from this area.

All the above said, Lee's book offers a simple method for selecting undervalued stocks from the universe of the Dow Jones 30 Industrials. Best yet, the raw data is available for free on the Value Line web site. The author uses past data to derive an average benchmark based upon how the issue previously traded against its book value. (Academic research has shown price versus book value to have some predictive ability.) I have performed sample testing on Lee's method and feel that it is useful in providing the average investor a fighting chance in: 1) safeguarding one's capital funds; and 2) earning a reasonable (if not superior) rate of market return. (Superior returns are possible, however I feel very strongly that such superior returns are often the product of sufficient capital, stringent loss control, the direction of the secular trend, selection of the appropriate vehicle, and L-U-C-K.)

I believe that Lee's methodology makes sense and is workable for somebody wanting to manage one's own investment funds and understand the process of stock selection. While this method is not perfect and will probably lead to less than perfect results, it will likely provide satisfactory long-term results for the individual investor who doesn't mind crunching his or her own numbers.

I love the strategy this book unveils. Now, it appears Ken has a website where the method is applied to not only Dow Stocks, but also the S&P 100 and Nasdaq 25. If you're in investing for value and the long-term, this site may be worth the price...

Though this book presents an interesting investment methodology, when I tried to apply it to the Dow stocks, and other stocks that I own, I saw some immediate flaws that I could not circumvent. 10 years is a long time and most, if not all companies change big time during this time frame. This presents a major problem in using 10 yr averages of high/low prices, ROEs, etc. It is like comparing apples to oranges. Mergers, spinoffs, stock splits, etc. change the very data we are using to a degree that negates much of the practical implementation of this method. That is my opinion. The method would be more sound if companies didn't change in these ways..but they do. Some of these problems, for example, are obvious when looking at a 10 year trend in data, and , I see for example that according to the S&P report that I am looking at, the book value for ATT was between 9 and 10 in 1999, but now, according to its Yahoo profile..it is in the 20 range.They also spun off Lucent and AWE in past years..so how does one judge the numbers?

This is a great book for a value investor. It introduces the benchmark formula for investing in the best values in the 30 Dow stocks each year. It show the records of how this worked out in real time investing by beating the Dow average in most years. I really enjoyed the discussion of Warren Buffett;s strategies of focusing your money on a few great companies and buying those companies at 60 cents on the dollar.
The benchmark formula is as follows:
1. Find the average return on equity for the previous ten years.
2. Divide the current year's return on equity by its 10-year average return on equity to find the adjusted ROE ratio.
3. Find the average book value for the previous ten years. Also find the average low and high stock prices for the same period.
4. Calculate the stock's average yearly low price.
5. Find the average low and high market to book values for the previous 10 years. To do so, divide the average low and high prices by the average book value from step 3.
6. Find the downside target by first multiplying the stock's low market to book average multiple by the adjusted ROE ratio. The multiply that number by its current book value.
7. Find the upside target by first multiplying the stock's high market to book average multiple by the adjusted ROE ratio. Then multiply that number by its current book value.

You then will pick out the stocks trading at under their historical and projected value.

The 10 most undervalued stocks selected by benchmark investing (as taught in my book) from the S&P 100 averaged 51.20 percent in 2003 versus 23.84 percent for the index itself. The top five picks performed even better, up an average 80.82 percent.

Obviously, 2003 was a good year for stocks. But had you used benchmark investing beginning in 2000 until the end of last year, and bought the 10 most undervalued stocks from the S&P 100 you would have enjoyed a compounded total average return of 8.71 percent. During the same period, the index lost an average of -7.69 percent a year. So, you might want to take a look at benchmark investing in this book.

P.S. I do NOT have any web sites on the net, so don't assume I'm involved with any of them.

I found this book very thought provoking which is good. But, I checked out the test figures that he has in the back of the book with information found in the latest Value Line and the numbers don't jive. The author gives test figures for the reader to use so that they can make sure they are doing the math correctly. When I compared those figures with the actual figures in Value Line, they were inconsistent. For someone like myself who is not all that great at math to begin with, I need as much guidance and clarity as I can find. The author throws out terms but not all of them are clearly defined, this does not help when attemtpting to do complicated math equations. He would have been better off showing a copy of the Value Line pages that he mentions then highlight each area within that page as it relates to the terms he is using. Return on Equity, Book Value, Current Book Value, etc. mean nothing to me if I don't know where they are located on the Value Line page.