What Happened To Value Line? For decades there was no better way to beat the market than Value Line's stock-ranking system. WARREN BUFFETT AND PETER LYNCH love its research. But Value Line lost its magic just when technology transformed investing. CAN IT EVER COME BACK?
(MONEY Magazine) – The mercury nears 90[degrees]F this July morning at a gated community in Coral Gables, Fla. On the TV screen in Hank Hill's home office, the CNBC anchors sweat over the gyrations of the Dow and the Nasdaq. Hill has millions on the ride, yet the retired civil engineer is as calm as the lake that laps at the foot of his house.
It's Friday, which means that any moment now the mail will arrive with a list of stocks from a trusted source. Hill will match his portfolio to the 100 names on this week's list, adding and dropping maybe a dozen. He doesn't question the picks. He doesn't need to. His faith has become stronger over the past 13 years, as relying on the list has increased his portfolio 800% from $4 million to $36 million today.
The 83-year-old's secret lies not in some Wall Street insider's tipsheet but in the pages of a newsprint publication delivered each week to homes and libraries across the country. Hill surveys the big binders lining 40 feet of shelves in his office. "Why do I need anything else," he asks, "when I have Value Line?"
You remember Value Line, don't you? Its stock-ranking system was once hailed by the eminent economist Fischer Black as perhaps the only way to consistently beat the market. Its weekly list of picks was followed so closely by so many, it actually moved markets, each Friday creating what was known on the Street as the Value Line Effect.
It also was the one-stop source for a stock's financials. Though designed for the little guy--most users trudging to local libraries to wait their turn at the binders--plenty of big shots loved the trademark one-page summaries, including Warren Buffett, Charles Schwab and Abby Joseph Cohen. As Peter Lynch once said, "It's the next best thing to having your own private securities analyst."
You'd think the name that dominated individual investing since the Great Depression would be inescapable today, what with millions of new investors clamoring to make sense of an explosive market. Instead, Value Line teeters on the brink of irrelevance. Caught off guard by a technology revolution that consumed the business of stock information, the company has struggled to regain its footing. Potential subscribers have flocked to the Internet, where they can find up-to-the-minute data for free. Meanwhile, the vaunted ranking system has fallen off in recent years, mainly by failing to adapt to a fast-moving, tech-charged market.
Still, over the past 35 years, Value Line's system has beaten Standard & Poor's 500-stock index by eight percentage points annually. It's a claim no brokerage house or mutual fund can make. But can the greatest stock picker of the last century thrive--or even survive--in this one?
It's probably best to start just after the crash of '29, which wiped out the family fortune of a young New Yorker named Arnold Bernhard. Seeking a scientific way to predict market movements, the former journalist settled on a method that involved etching a graph of price history onto a transparency, then fitting it over a graph of earnings history--creating a "value line" that could be used to determine a good time to buy a given stock. Daughter and current CEO Jean Bernhard Buttner says her earliest memory is of licking stamps for mailings while her father peddled his product from door to door.
Value Line was nominally successful by the time Bernhard hired Sam Eisenstadt as a part-time proofreader in 1946. The Army vet from Brooklyn soon applied his college degree in statistics to translating the boss' ideas into standardized mathematical formulas. Each of the 300 stocks covered required different equations--and a full day of pounding on Monroe calculators that were larger than today's desktop PCs.
The system was inefficient, but there was a bigger problem. "It didn't work very well," Eisenstadt remembers. Gradually, a solution dawned on him. Rather than analyze stocks one by one, they could use powerful new machines called computers to compare one stock with thousands of others and thereby identify the most promising plays at any given moment.
Eisenstadt selected a number of factors by which to compare the stocks, including price and earnings history and price and earnings momentum. Then he set up a scoring system to separate the stocks into five different classes. The top class, or the 100 stocks ranked "1," had the highest likelihood of outstanding growth over the next six to 12 months. Or so he believed when Value Line finally rolled out these "timeliness rankings" in 1965.
Much of Wall Street laughed at the idea of using statistics alone to pick stocks, says mutual fund manager David Dreman, an analyst at Value Line at the time. Adds former Value Liner Bob Zuccaro, manager of Grand Prix fund: "The model used price momentum, which no one really understood."
But it worked. From 1965 through 1970, the timeliness rankings returned an annual average of 17.2%, walloping the S&P 500's 5.1%.
Of course, there were skeptics. Some felt the market was so efficient that no man-made system could beat it. The father of this theory, Fischer Black of the University of Chicago, even challenged Bernhard to a debate. Bernhard silenced him with records of his results, then invited Black to study the system himself.
After four months at Value Line, Black wrote an influential paper for the Financial Analysts Journal. Published in 1973, the piece opened by restating Black's belief that stock picking is a loser's game. Then he conceded: "The Value Line ranking system appears to be one of the few exceptions....Most investment management organizations would improve their performance if they fired all but one of their security analysts and then provided the remaining analyst with the Value Line service."
Value Line's reputation was set. College grads lined up for jobs as analysts; some, including Jeff Vinick and Sanford Bernstein, would later gain fame as money managers. Abby Cohen's stint there cemented her admiration. "It was an enormous compendium of data at a time when there wasn't that much data available," she says.
Charles Albers, who now manages $20 billion for Oppenheimer Funds, was a Value Line analyst around the time the timeliness rankings were launched. When he left to run Guardian Park Avenue fund, the system remained a major factor in his stock-picking model. "I was a young and green fund manager--but I was practical," he explains. "I knew that this tool worked."
And how. In the 1970s, the top stocks in the timeliness rankings returned 23.1% annually, flattening the S&P's 5.8%; in the '80s, they hit 25.4% vs. the S&P's 17.5%.
Naturally, such success drew critics. Robert S. Salomon Jr., a longtime money manager, evaluated the timeliness rankings with Andre Perold, a Harvard finance professor, at the close of the '80s. "I was intrigued," says Salomon, "by the disparity between that incredible rec-ord they achieved on paper and their inability to translate it into real money."
Salomon is referring to the Value Line mutual funds, the first of which was launched in 1950. When the timeliness rankings came about, the fund and its sisters adopted the system. It was a no-brainer: The 100 top stocks in the rankings already amounted to what was in essence the world's greatest mutual fund. But there was a problem. The funds lagged the rankings--badly. Only twice from 1970 to the mid-'90s did the flagship Value Line fund match the top stocks; usually it fell embarrassingly far behind.
How could that be? Salomon and Perold and others showed that Value Line did not include the costs of real-life trades (commissions, spreads and taxes) in its extraordinary paper returns. Those costs could be punishing for a portfolio in which the average stock is held just four months. Also, the rankings failed to account for the inevitable warping of a stock's value when Value Line's considerable audience, plus its mutual funds, bought into the same stock at the same time.
Outside of mutual funds, though, most individuals couldn't truly follow the weekly timeliness rankings. You needed a portfolio of 100 stocks, and who has the money for that? Only the wealthiest, like Hank Hill. And only a retiree like Hill could spare the many hours needed for record keeping.
Eisenstadt contends that investors could still beat the market by choosing a random selection of the top-ranked stocks quarterly or even annually. In any case, many customers devised their own uses for the rankings. Investment clubs relied on them to help narrow their picks. Even if they didn't follow the rankings, many users cherished Value Line for its comprehensive, unbiased research. Subscriptions rose to 100,000 in the 1980s--and many of the subscribers were libraries, hoisting the probable readership to the millions.
When the '90s bull market roared to life, Value Line had every reason to feel confident. It had the brand name and the unbeatable record. Arnold Bernhard had died in 1987, and the reins had passed to his Harvard M.B.A. daughter. But the world was about to turn upside down.
With the Internet's arrival, stock information was available instantly, to everyone, and usually for free. Mutual funds and e-brokerages made investing cheap and easy. The market became sport.
Value Line should have reigned supreme in this new game. Yet it fumbled almost every opportunity. With mediocre returns and virtually no marketing, its mutual funds remained obscure, with just $2.9 billion in assets today. Value Line finally began covering the exploding fund industry in 1993, nine years after an upstart called Morningstar began grabbing market share. And the first electronic version of the investment survey didn't appear until 1996--in already-passe CD-ROM form.
In a rare interview, CEO Buttner, 65, explains her reluctance to move quickly into new arenas. "I have been careful to guide the company so we're not the first," she says, "so we can watch others make mistakes."
Expansion has never been high on her to-do list, which helps explain why she has rejected dozens of corporate suitors--including, reportedly, Charles Schwab.
Lacking major new products or alliances, Value Line faded from view in the bull market. It re-emerged now and then amid damaging reports of an ugly family battle for control of the company, and a Yahoo! message board where employees posted brutal attacks on the CEO's fitness to manage. No wonder Value Line's stock--80% of it controlled by Buttner--has grown just 4.4% since 1992, despite steady profits and a debt-free balance sheet.
Worst of all, the timeliness rankings hit hard times. Though designed to romp in growth- and momentum-driven periods, Value Line's top-ranked stocks consistently underperformed the S&P 500 beginning in 1994. In 1997, the difference was 22 percentage points; in 1998, 20 points. Over the past five years, the top picks returned 15% annually--far below the market's 23.8%. It was a crushing downfall for a system that had lagged only four times from 1965 to 1990. The verdict: The market had changed; Value Line had not.
Technology had dramatically increased the speed with which we spread information and trade stocks. Now, a stock's outlook can change in the blink of an eye--a problem for a system that relies solely on historical data and is updated only once a week.
Take the case of Steve Madden, a shoe company whose owner was arrested June 20 on charges of fraud. When the news hit, the stock plunged 53% in a day. Yet in July, Steve Madden still remained among Value Line's second highest rankings, which indicates the stock is due to outperform the market. "It's an embarrassment that we still rank it a 2," says Eisenstadt. "But because we use a 10-week average of prices, that's where the system says it belongs."
The arrival of dotcom stocks wreaked further havoc. Because a two-year price and earnings history is required, the 1,700 names in the rankings exclude many of the most explosive in the New Economy, including eBay, Ariba and Network Solutions. (Only 12 Internet stocks make the cut.)
But the biggest problem may come to this: The rankings stopped working because they worked so well. "Value Line changed the market, ultimately to its own detriment," contends Albers of Oppenheimer. "The formula took advantage of gross inefficiencies in the market, and that's why it worked so well in the '60s and '70s. As other people picked up on the fundamentals and stock prices became more efficient, its usefulness eroded away."
There's that old saying: In the kingdom of the blind, the one-eyed man is king. "Well," says Albers, "now there are many one-eyed men."
How can Value Line rule its kingdom again? It's a question that haunts Sam Eisenstadt, who, at 78, remains at the firm out of profound loyalty (evidenced by the Value Line tiepin he wears every day). "I'm going to keep on chipping away." He pauses, adding a touch dolefully: "But with everyone else looking, I don't know why we'd find it first."
Conquering this changed market, he says, will require radical changes. Like dropping the simplistic 1-to-5 rankings and instead charting the entire universe of stocks, from A to Z. And running the rankings daily, or even hourly, delivering them on the Internet. "We have to go in that direction," Eisenstadt says.
CEO Buttner says she's considering some changes, but doesn't express much urgency. "First of all, there's no system I'm aware of that's been as successful," she says. "And we have to think about our older subscribers, who aren't as used to the Internet."
Standing still has its dangers. As one skeptical user predicts on a Web message board: "Eventually, all of the retired dentists in Florida will pass away and the Value Line Investment Survey will be properly placed in the Museum of Natural History."
But Value Line isn't ready for eulogies yet. For one thing, it's still a tremendous resource. "The more confused the investing world becomes," notes former electronic publishing director Steve Savage, "the stronger the need for a solid, blue-chip, independent source you can trust."
For another, by the end of 1999, core stock picks like Qualcomm and JDS Uniphase had helped the system slip past the market with a 24.9% return. As of mid-2000, Value Line's top-ranked stocks had gained 8.8% for the year vs. -0.4% for the S&P 500. Even including that dismal mid-'90s stretch, the system was recently ranked the No. 1 stock picker out of 16 newsletters tracked for 20 years by the Hulbert Financial Digest. Value Line's annualized gain: 17.6% vs. the S&P's 17.4%.
And--at long last--the electronic age has come to Value Line. The revamped version of the software introduced in 1996 is a powerful program, with cool filtering functions and weekly rankings that can be downloaded off the Web. A website relaunched in July features live feeds of commentary from Value Line analysts and fund managers broadcast from a new Webcast studio.
These are the sort of tools that should make today's e-traders drool. If only they knew about them.
Dirk Hrobsky is a 28-year-old commercial real estate broker in Manhattan. On the same Friday morning in July that Hank Hill waits for his mail, Hrobsky is whizzing around the Web, looking for tidbits on a stock that's burning up the chat rooms. He's built $16,000 into a mid-six-figure portfolio since late '98, buying tech and IPOs on tips gleaned from buddies and the Internet.
"Value Line?" he asks. "What's Value Line?"
Just to be sure he's not out of the loop, Hrobsky calls a bunch of his market-playing pals. Nope. Never heard of it.
In the stock market of the 21st century, that's not a good sign.