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This chapter is from the book

Value Line

The Value Line Investment Survey has been a very popular source of stock-picking advice for many decades. The long-term success of its stock ranking system has caused the Value Line publications to be purchased by tens of thousands of subscribers. As they are in nearly every library, the readership could easily be in the millions. The Value Line firm itself has produced some employees that later went on to investment fame, such as money managers Charles Albers (Oppenheimer Funds), Sanford Bernstein (Bernstein Investment Research and Management), Abby Cohen (Goldman, Sachs & Co.), and Jeff Vinick (previously of Fidelity Magellan). Others, like Warren Buffet and Peter Lynch, have publicly hailed its research and ranking system.

The most popular of Value Line's stock ranking systems is the timeliness ranking. Some 1,700 stocks are ranked into five categories (1 to 5), where a ranking of 1 means the firm has the highest likelihood of outstanding growth over the next year. Investing in the 100 firms given by this top ranking are reported to give the investor outstanding returns. Indeed, these firms outperformed the S&P 500 Index by an eye-popping average 17.3% per year in the 1970s.11 The highly ranked firms outperformed the S&P again in the 1980s by 7.9% per year.

With stock-picking successes like these, it must be easy to make money. However, Value Line was unable to turn this predictability into high returns. Value Line mutual funds consistently ranked below the S&P 500 Index. How is this possible?

One of the problems with following the 100 stocks picked by Value Line's timeliness rankings is that the stocks change very frequently. If you were to purchase the 100 stocks on the list that is published every week, you would find that the stocks frequently change. Indeed, you would find that you hold a stock an average of only four months before it is dropped from the list. The heavy turnover of stocks in the ranking system results in a high degree of trading. Thus, the transaction costs of implementing a Value Line strategy could be very high.

The importance of transaction costs is detailed in Chapter 7. However, if the cost of buying and then selling a stock is 2% (it is actually higher), then buying new stocks every four months causes you to incur a cost of 6% year in transaction costs. Value Line's stock picks would have to beat the market by 6% in order for you to recoup the transaction costs associated with the high degree of trading. A study of the performance of the stocks ranked 1 in timeliness finds that, over the period 1965 through 1996, the stocks do not beat the market after accounting for transaction costs.12 This suggests that if you are looking for a stock or two to buy and hold, the recommendations by Value Line may be something to consider. However, using the recommendations as a trading strategy may not work well. Indeed, many investors don't have the wealth necessary to buy all 100 stocks recommended anyway.

Even with Value Line's past successes, it may have already become pass . The success of the timeliness ranking fell in the second half of the 1990s. For the latter half of the 1990s, Value Line recommendations underperformed the S&P 500 Index by nearly 9% per year. This is surprising because the timeliness ranking is biased toward growth-oriented firms that, as a group, did well during that period. Even more surprising is the snail's pace in which Value Line embraced both providing the rankings in computer format and getting them listed on the Internet. They launched a useful Web site for investors in July 2000. This occurred well after the rise of investment Web sites. Indeed, Dirk Hrobsky, a 28-year-old online investor who manages his mid-six figure portfolio hadn't heard of Value Line before.13 Neither had his chatroom investor buddies.

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