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Chapter 2. Evaluating Risk > Does Low Valuation Equal Low Risk?

Does Low Valuation Equal Low Risk?

Several academic studies found that portfolios made up of low valuation stocks, say those with low P/E ratios, outperformed high valuation portfolios over various time frames. In other words, value-priced stocks outperform growth stocks. That sounds like news that you can use, but when you delve into the details, you'll find that just a few stocks account for the value portfolio's outperformance. It turns out that most stocks making up those portfolios actually lost money.

To illustrate that phenomenon, I made up a portfolio of deep-value stocks. These were stocks that as of February 2001 had price/book ratios between 0.1 and 0.5. I call them deep-value stocks because usually a price/book ratio below 1.0 is enough to qualify a stock as value-priced. A total of 501 stocks met my deep-value requirements.


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