I REALLY like this paper. Looking for extra information at the extremes makes more sense to me than just decile stats. Here is the AlphaLetters Journal review, and if you would like more in-depth analysis, check out the always thorough CXO Advisory. The author’s website can be found at Improving the P/E Ratio.
Category: Value, Extreme value measure
Title: Extreme Returns From Extreme Value Stocks: Enhancing the Value Premium
Author: Keith Anderson; Chris Brooks
Source: The Journal of Investing, Spring 2007
Link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=739667
Abstract: Investigations into value-based ‘anomalies’ such as the P/E effect typically sort shares into quintiles, or at most deciles. These are blunt instruments. We test whether most of the extra value in the lower end of the P/E spectrum is to be found in the very lowest P/E shares, and whether the worst investments reside in the few shares with the highest P/E. Using a long-term definition of earnings, and attributing influences on the P/E to company size and sector, we find that small portfolios of value shares give returns of 40%+ per annum, while small portfolios of glamour shares give returns less than the risk free rate. We thus show that by more judicious use of the P/E ratio, we can considerably enhance the value premium.
