What this shows is that the more expensive stocks are at any point, the lower their future return is likely to be. Diane Strandberg, director of international equity at Dodge & Cox, believes that understanding this is one of the tree pillars of value investing. “Valuation starting point matters,” Strandberg told the recent Morningstar Investment Conference in Cape Town. “It is the most powerful determinant of long term return – more powerful than GDP growth, earnings growth or other measures that we might look at.”
The good news for investors, she points out, is that this starting valuation is easily observable. This is why investing based primarily on starting valuations is essentially simple. It is not, however, easy. That is because it often requires investing in parts of the market that others find unappealing, and staying away from those parts of the market where sentiment is most positive.
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