In this blog post we explore a strategy that buys cheap companies with high return on assets. To measure the performance of this strategy we created an Index of such stocks and rebalanced it yearly, investing equally among the chosen stocks. In quantitative terms, the stocks we picked at each rebalance satisfied the following criteria:
- member of the S&P 500, and of these
- among the 50 lowest by P/E ratio, and of these
- among the 15 highest by return on assets.
The chart below shows the performance of our Index if we had started investing on January 1st, 1995.
Although the Index suffers during the current recession, it makes it through the Internet bubble with only a hiccup. This is probably because technology stocks that participated in the bubble were excluded by their high P/E ratios. Using Chart in a direct comparison to the S&P 500 we see that our Index of cheap, efficient companies outperforms the market dramatically.