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What Has Worked in Investing is an attempt to share with you our knowledge of historically successful investment characteristics and approaches. Included in this booklet are descriptions of over 50 studies, approximately half of which relate to non-U.S. stocks.

Our choice of studies has not been selective; we merely included most of the major studies we have seen through the years. Interestingly, geography had no influence on the basic conclusion that stocks possessing the characteristics described in this booklet provided the best returns over long periods of time.

While this conclusion comes as no surprise to us, it does provide empirical evidence that Benjamin Graham’s principles of investing, first described in 1934 in his book, Security Analysis, continue to serve investors well.

A knowledge of the recurring and often interrelated patterns of investment success over long periods has not only enhanced our investment process, but has also provided long-term perspective and, occasionally, patience and perseverance. We hope this knowledge will also serve you well.

The basic investment selection criteria described in What Has Worked in Investing have been incorporated in Tweedy, Browne’s investment screening and decision making process since at least 1958, when Tom Knapp, a retired partner, joined Tweedy, Browne from Benjamin Graham’s investment management firm, Graham-Newman Corporation.

Most of Tweedy, Browne’s investments have had at least one, and, more frequently, several of the investment characteristics which are described in this booklet.

The criteria and characteristics have been utilized by Tweedy, Browne because they pointed, like clues, in the direction of truly undervalued companies; appealed to common sense; and because the managing directors have always believed that undervaluation, which is associated with low risk, would also be associated with satisfactory returns.

In addition to the confirmation provided by our own historical investment results spanning nearly 50 years, the extensive studies described in this booklet, in our judgment, have empirically confirmed that the fundamental approach to security analysis developed by Benjamin Graham, and long practiced by Tweedy, Browne, produces attractive long-term rates of return.

Most investments in Tweedy, Browne portfolios have had, and continue to have, at the time of purchase one or more of the following characteristics:

1. Low Price in Relation to Asset Value

Stocks priced at less than book value are purchased on the assumption that, in time, their market price will reflect at least their stated book value; i.e., what the company itself has paid for its own assets. From time to time, we also have been able to find stocks selling at discounts to net current assets (i.e., cash and other assets which can be turned into cash within one year, such as accounts receivable and inventory, less all liabilities), a measure of the estimated liquidation value of the business.

This was a stock selection technique successfully employed by Benjamin Graham.

2. Low Price in Relation to Earnings

Stocks bought at low price/earnings ratios afford higher earnings yields than stocks bought at higher ratios of price-to-earnings.

The earnings yield is the yield which shareholders would receive if all the earnings were paid out as a dividend. Benjamin Graham recommended investing in companies whose earnings yield was 200% of the yield on AAA bonds.

Investing in stocks that are priced low in relation to earnings does not preclude investments in companies whose earnings are expected to grow in the future. To paraphrase Warren Buffett, “value” and “ growth” are joined at the hip.

A company priced low in relation to earnings, whose earnings are expected to grow, is preferable to a similarly priced company whose earnings are not expected to grow. Price is the key.

Included within this broad low price in relation to earnings category are high dividend yields and low prices in relation to cash flow (earnings plus depreciation expense).

3. A Significant Pattern of Purchases by One or More Insiders (Officers and Directors)

Officers, directors and large shareholders often buy their own company’s stock when it is depressed in relation to the current value which would be ascribable to the company’s assets or its ongoing business in a corporate acquisition, or to the likely value of the company in the near to intermediate future.

Insiders often have “insight information”— knowledge about new marketing programs, product price increases, cost cuts, increased order rates, changes in industry conditions, etc., which they believe will result in an increase in the true underlying value of the company.

Other examples of insider insights are: knowledge of the true value of “hidden assets,” such as the value of a money-losing subsidiary which a competitor may have offered to buy, or the value of excess real estate not required in a company’s operation, or knowledge of the likely earning power of the company once heavy non-recurring new product development costs stop.

It is not uncommon to see significant insider buying in companies selling in the stock market at low price/earnings ratios or at low prices in relation to book value.

Frequently, companies in which we have invested have also purchased their own shares in the open market.

4. A Significant Decline in a Stock’s Price

A decline in price is often accompanied by a decline in earnings or an earnings disappointment. Reversion to the mean is almost a law of nature with respect to company performance.

We have found that, more often than not, companies whose recent performance has been poor tend to perk up and improve.

5. Small Market Capitalization

Since our investment process at Tweedy, Browne incorporates the entire universe of publicly traded companies, it is not surprising that our portfolios have held, and continue to have exposure to, smaller capitalization companies.

Most publicly traded companies are small in terms of their market capitalization.

Furthermore, these companies are often associated with higher rates of growth and may, due to their size, be more easily acquired by other corporations.

It has not been uncommon for the investments in our portfolios to simultaneously possess many of the above characteristics.

For instance, companies selling at low prices in relation to net current assets, book value and/or earnings are frequently priced low in relation to cash flow, have a high dividend yield and are smaller in terms of their market capitalization.

More often than not, the stock price has declined significantly from prior levels; corporate officers and directors have been accumulating the company’s stock, and the company itself is engaged in a share repurchase program.

Furthermore, these companies are often priced in the stock market at discounts to real world estimates of the value shareholders would receive in a sale or liquidation of the entire company.

Each characteristic seems somewhat analogous to one piece of a mosaic. When several of the pieces are arranged together, the picture can be clearly seen: an undervalued stock.

Dr. Josef Lakonishok (University of Illinois), Dr. Robert W. Vishny (University of Chicago) and Dr. Andrei Shleifer (Harvard University) presented a paper funded by the National Bureau of Economic Research entitled, “Contrarian Investment, Extrapolation and Risk,” May 1993,

which examined investment returns from all companies listed on the New York Stock Exchange (NYSE) and American Stock Exchange (AMEX) in relation to ratios of price-to-book value, price-to-earnings and price-to-cash flow between 1968 and 1990.

In their abstract, the authors state, “This paper provides evidence that value strategies yield higher returns because these strategies exploit the mistakes of the typical investor and not because these strategies are fundamentally riskier.”

A subsequent paper, interestingly co-authored by Burton G. Malkiel, the Princeton Professor and author of A Random Walk Down Wall Street, which argues against the efficacy of actively managed investment strategies in favor of index funds, investigated whether the predictable return advantages associated with contrarian strategies set forth in previous empirical studies was persistent and exploitable by investment managers.

In this study published in The Journal of Economics and Statistics (May 1997) entitled, “The Predictability of Stock Returns: A Cross-Sectional Simulation,” Zsuzsanna Fluck (New York University), Burton G. Malkiel (Princeton) and Richard E. Quandt (Princeton) examined the performance of 1,000 large-company stocks ranked by price/earnings ratios and price-to-book value ratios from 1979 through 1995, and confirmed the findings of the previous Lakonishok, Shleifer and Vishny study, “Contrarian Investment, Extrapolation and Risk,” finding that,

On a sample of large companies that is free from selection bias, we have concluded that the superior performance of contrarian strategies, documented by earlier studies is not simply an artifact of selection bias. We have also found that the result is robust with respect to transaction costs.

The papers by Fluck, Malkiel and Quandt, and by Lakonishok, Shliefer and Vishny, together with similar studies described in the “Assets Bought Cheap” and “Earnings Bought Cheap” sections of What Has Worked In Investing demonstrate that, at the extreme, investors overvalue and undervalue individual stocks, and that the best returns come from buying stocks at the extreme end of the value spectrum.