The Evolution of the Stock Market during the past century involved major changes in thinking about stock portfolios. Here are some of the major changes.

Growth: Early in the 20th century Roger W Babson developed the concept of buying securities for their future growth prospects and not strictly for their dividend income. Growth investing seemed to appeal to the American spirit and became very popular here . John Templeton took advantage of the fact that foreign investors were late to catch on and he built an investment powerhouse applying growth concepts to international securities. Stocks that were not Growth stocks were called Value stocks. There are fans of each of these two approaches. The latest research however found that historically the best performance occurs when securities have both Growth and Value characteristics. There is also a trend to measuring growth of cash flow rather than the company’s earnings.

Value: Value investing changed from simply being the other non-growth group when Benjamin Graham suggested that Value should be measured by the assets less the liabilities (Book Value) of a company. Investors should buy when the stock price is substantially below the book value per share. Dodd’s student Warren Buffett suggested that this approach was incomplete. You spent a lot of time finding the bargain, the stock went up to its fair value and you had to sell and start again. He described it as finding a cigar butt getting one puff and having to search for another butt. Buffett suggests long term holding of great companies at good prices rather than good companies at great prices. James O’Shaughnessy found that Shareholder Yield, (Dividends plus Share Buybacks) historically outperformed all other value factors since 1926.

Quality: Quality originally was described as a series of financial numbers, the company paid a dividend, raised the dividend annually, grew earnings, etc. Once again Warren Buffet had an impact by suggesting that Quality is an Economic Moat that protects the company from competition. Historically, Standard and Poor’s had a Quality score for Stocks, and a white paper on how higher quality stocks outperform. S&P changed the name of the factor from Quality to S&P Rating probably because of High Quality’s reputation as a negative factor for investing. (See Safety)

Safety: Safety started out as a concern for bankruptcy. As the bankruptcies of companies declined and a demand for a simplified, computerized, Safety criteria increased. Safety was redefined as Volatility. High levels of Safety (and Quality) have been thought of as negative factors when seeking performance because high quality, safe, Bonds, AAA ranked, underperform lower quality Bonds. AAA bonds pay lower interest rates and cannot earn a higher rating that would increase their price. So, an assumption can be made that high-quality stocks also underperform. Also, Investing was considered gambling so why not use gambling’s higher risk is required for higher reward rule. It is common for advisors to recommend higher levels of risk to improve results. The rule is so pervasive that few even considers a research project to see if it is true.

Our four-factor model, Safety, Quality, Growth and Value was introduced in 1968. I am pleased that the market has evolved and more of our factors are being verified. I am also pleased that the improvements we have made over the years has kept us ahead of the crowd.

Katz Family Financial