24 The Business of Value Investingtook all the stocks on the New York Stock Exchange, American
Stock Exchange, and NASDAQ that had reliable data and grouped
them into 10 groups based on the book - to - price ratio (B/P; the
fl ip of the P/B ratio, thus making a higher book - to - price stock an
indicator of value). The fi rst group contained the most extreme value
stocks (lowest P/B or highest B/P [both are the same]) while the tenth
group contained the most extreme growth stocks. Analyzing the returns
over 27 years that included both up and down markets, they found that
the Group 1 extreme value stocks went up nearly seven times in price
( ~ 600 percent) in 10 years, or nearly a 21 percent annualized gain,
while the Group 10 extreme growth stocks doubled in price over 10
years, or about an 8 percent annualized rate of return.
Although I fi nd the P/E and P/B values useful, unless you
decide to buy hundreds of low P/B stocks and hold them for 27
years, I wouldn ’ t bank on them completely in making investment
decisions. One of the greatest investors, Sir John Templeton,
bought $ 100 of every stock trading below $ 1 on the New York and
American Stock exchanges in 1939 on the heels of World War II.
This well - known trade gave Templeton a basket of 104 compa-
nies for a total investment of $ 10,400. Thirty - four went bankrupt,
but four years later. Templeton sold his holdings for more than
$ 40,000. Again, unless you want to go out today and buy the thou-
sand of stocks trading for less than $ 1, I wouldn ’ t count on many
penny stocks as being undervalued businesses.Price Determines Value
The most common cause of low prices is pessimism — sometimes
pervasive, sometimes specific to a company or industry. We want to
do business in such an environment, not because we like pessimism
but because we like the prices it produces. It ’ s optimism that is the
enemy of the rational buyer.
— Warren Buffett, 1990 Berkshire Hathaway
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