The Best Record Around

 

They call it the Value Line Enigma, and it is a stumper.

Amidst all the on-again, off-again, performance of everyone who plays the market there is one investment adviser that, pretty consistently, beats the averages. Value Line Inc. It is the biggest investment advisory service around, which means that, although people may be puzzled by its performance, they aren't stupid. This year some 110,000 subscribers coughed up $365 apiece for the company's major publication, The Value Line Investent Survey.

Rather than telling its subscribers exactly where to put their money, Value Line ranks stocks. Its criterion is what the industry calls timeliness -- that is, the stocks' likely performance over the next 12 months. Top-ranked stocks are likely to do well, bottom-ranked stocks to do poorly. Over the years, several academic studies have found, Value Line's top group outperformed the market averages with startling regularity.

How to explain it? "I don't know," confesses Fischer Black, a professor of finance at Massachusetts Institute of Technology and a proponent of efficient-market theory, which argues that almost no one can do what Value Line does.

It is tempting to ascribe the company's success simply to the hard work of two men, founder Arnold Bernhard, now 81, and chief statistician Samuel Eisenstadt, 61. Bernhard, a onetime drama critic turned securities analyst, founded the company in the 1930s. Maybe, he thought, he could examine companies' earnings records and past stock prices and come up with some indications of when to buy and when to sell. Eisenstadt, fresh out of the service, joined Bernhard in 1946. Trained in statistics, he began figuring out how to include a range of other variables in Bernhard's formulas.

It took nearly 20 years, though, before Eisenstadt came up with a system he felt satisfied with. The same system has been in effect since then and is apparently what has enabled Value Line to beat the averages so consistently. The odd thing about the system is that it relies not at all on human judgment. Instead, it depends entirely on publicly available information, mainly about company earnings over time. The firm tried incorporating its analysts' judgments about stocks in its recommendations, Eisenstadt explains, but found only that the analysts encouraged unnecessary trading.

Making money on Value Line's rankings, however, is not quite as simple as it sounds. For one thing, the firm tracks some 1,700 companies, as compared with the 1,000 to 1,200 tracked by the largest brokerage firms. Its top-ranked group includes 100 stocks, more than most individuals would want in a portfolio That leaves the investor to choose which stocks to buy and sell -- and leaves him vulnerable to the fact that, as one executive puts it, "one out of three stocks does not perform in line with its ranking."

Then, too, companies are added to and dropped from the top ranking quite rapidly. Investors who tried to keep up with all the recommendations would thus find themselves trading frantically, paying inordinately large commission costs, and losing a good deal in taxes.

For an individual, therefore, the wisest course might be to select a portfolio from Value Line's top rankings once or twice a year. Even on that basis, the company has been shown to outperform the market. As for selecting stocks from within the rankings, that has to be done with an eye to individual needs. Some people will want safety (Value Line ranks all its stocks on this basis as well). Others will want income, and still others growth.

Why hasn't Value Line's system been copied by other investment advisers? "We reveal enough about how we work so people could duplicate it," says Eisenstadt. But, he notes, the cost of getting started may be prohibitive. The system requires a huge database and extensive use of computers.

In that case, why doesn't everyone use Value Line? Eisenstadt's explanation is simplicity itself. "I believe," he says with a chuckle, "that there are a lot of closet Value Line users around."