Despite the higher returns provided by value-based firms, there is one class of stocks, those of distressed firms, that has achieved some fo the highest returns of all.
Many distressed firms have negative earnings and zero or negative book value and pay no dividends.
Research has shown that as the ratio of book value/price or earnings/price declines, so does the return. However, when book value or earnings turn negative, the price of the stock becomes so depressed that the future returns soar.
This same discontinuity is also found with dividend yields. The higher the dividend yield, the higher is the subsequent return. However, firms that pay no dividend at all have among the highist subsequent returns.
Research revealed that most stocks that have negative earnings or negative book values have experienced very adverse financial developments and have become severely depressed. Many investors are quick to dump these stocks when the news get very bad. This often drives the price down below the value justified by future prospects. Few investors seem able to see the light at the end of the tunnel or cannot justify - to themselves or to their clients - the purchase of such stocks under such adverse circumstances.
(Note: Tongher)
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