U.S Large Cap Value Stocks include those stocks that generally include U.S. companies with market capitalizations within the largest 90 percent of the market universe. After identifying the aggregate market capitalization break, a value “screen” can be applied; securities are considered value stocks when they have a high book value in relation to their market value (BtM).

 Over the long term (since 1927) Large Cap Value stocks have generated higher annualized returns than the overall stock market, as measured by the S&P 500 Index. This is explained by the inherent trade-off between risk and return. Value companies, being in a distressed state, carry high economic risk and have higher costs of capital than larger and financially healthy companies. When they take out a loan from a bank, they pay (and investors receive) higher interest rates; when they issue stock, they receive (and investors pay) lower prices. A firm’s cost of capital is the investor’s expected return.

Because of their inherently higher level of risk, distressed companies have higher expected returns than companies that are healthier. Research and historical results show that long-term increases in expected returns can be achieved with value exposure. Such premiums cannot be gained by stock selection or market timing, nor can it be gained through various other segmenting schemes promoted by active managers, such as “bets” on industrial sectors or individual countries.

Our research suggests that the most reliable means of identifying a distressed stock (to distinguish value from growth stocks) are its BtM or its dividend yield. We utilize index-type mutual funds and exchange traded funds that sort these stocks by BtM. For larger accounts, especially those with an explicit need for investment income (such as certain trust accounts) we utilize dividend yield as our gauge, through our “4-for-18” high-yield Dow approach, in which we purchase equities directly.

Our HYD model began by incrementally “investing” a hypothetical sum of $1 million over 18 months. Specifically, one eighteenth of $1 million ($55,000) was invested equally in each of the 4 highest-yielding issues in the Dow Jones Industrial Average each month, beginning in July 1962. Once fully invested (January 1964) the model began a regular monthly process of considering for sale only those shares purchased 18 months earlier, and replacing them with the shares of the four highest-yielding shares at that time. The model each month thus mechanically purchases shares that are relatively low in price (with a high dividend yield) and sells shares that are relatively high in price (with a low dividend yield), all the while garnering a relatively high level of dividend income.