What I Learned About Investing from Darwin by Pulak Prasad

Author:Pulak Prasad
Language: eng
Format: epub
Tags: BUS050020, Business & Economics/Personal Finance/Investing, BUS036000, Business & Economics/Investments & Securities/General
Publisher: Columbia University Press
Published: 2023-05-23T00:00:00+00:00

1. Invest at a high valuation hoping that the price will rise further, or

2. Stay inactive for long periods until we get the price we want.

We have always chosen option two. Why? Convergence. Valuation matters for equity returns over the long run across years, countries, and the size of companies. The lower the valuation, the higher the prospective long-term returns. It has worked everywhere over very long periods, so who are we to defy it?

There is a lot of empirical research on equity valuation and returns. The article on this topic that I like best is “Value and Growth Investing: Review and Update” by Louis K. C. Chan and Josef Lakonishok.14 I love this article for two reasons. First, it is a meta-research article that summarizes the conclusions of many other researchers over many years across several countries. Second, while Chan and Lakonishok are both academics (from the University of Illinois at Urbana-Champaign), Lakonishok is also the CEO and chief investment officer of a $100 billion fund called LSV Asset Management. It’s always good to hear from people whose research conclusions matter to their bank balance.

The article has many tables with reams of data, and if you don’t have much time, I suggest focusing on table 2. It shows returns over twenty years (from 1975 to 1995) across thirteen countries for “value” stocks (those with low valuation) and “glamour” stocks (those with high valuation) across four valuation measures. The results are stark. The value portfolio beats the glamour portfolio across almost all countries. And the outperformance is not trivial: It ranges from 1.5 percentage points for Switzerland to 6.7 percentage points for the United States (based on PE ratio as the valuation measure).

The first paragraph of their conclusion is worth repeating in full:

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