Inside the Investment Strategy of John Neff

Inside the Investment Strategy of John Neff

Who is John Neff?

John Neff was the legendary manager of Vanguard’s Windsor Fund from 1964 to 1995. During his three-decade tenure, the fund averaged a 13.7% annual return, beating the S&P 500 by an average of over 3 percentage points per year. That track record made him one of the greatest investors of all time. Neff’s approach was, in his own words, “relatively prosaic, dull, [and] conservative.” He focused on beaten-down, unloved stocks with low price-earnings ratios. Neff believed that as long as a company was fundamentally sound, a low P/E meant it had been oversold and was due for a rebound. Neff detailed his low P/E approach in his book John Neff on Investing. Originally published in 1999, it provides a straightforward look at how Neff used a combination of low multiples and fundamental strength to find winning stocks again and again.

The Neff-Based Validea Model

Validea used John Neff on Investing and other public sources to build a quantitative model that encapsulates Neff’s approach. The model looks for stocks with the following characteristics:

  • P/E Ratio: The P/E must be 40-60% of the market average to find companies that are out of favor. However, the P/E must be above 5 to avoid weak companies.
  • Earnings Growth: EPS growth must be between 7% and 20% on average over the past 3, 4 and 5 years. Very high growth rates often can’t be sustained.
  • Future Growth: Analysts’ consensus estimates for long-term and current year EPS growth must both be over 6%.
  • Sales Growth: Sales growth over past 3, 4 and 5 years must be either over 7% or at least 70% as high as EPS growth, showing growth is driven by sales, not cost-cutting.
  • Total Return/PE: The sum of the EPS growth rate and dividend yield, divided by the P/E, must be at least twice the market or industry average, showing a stock provides a lot of “bang for the buck”. The model also looks for persistent year-over-year increases in quarterly earnings, and gives extra credit for positive free cash flow.

Current Neff-Type Stocks

Here are four stocks that currently earn high marks from Validea’s Neff-based model:

  • Dick’s Sporting Goods (DKS): Dick’s is a full-line sporting goods retailer with over 850 stores. It has a P/E of 15.3, 43% below the market average. EPS have grown an average of 34% per year over the past 3-5 years and sales 10% per year. Quarterly EPS have increased each of the past 4 quarters vs. the year-ago periods. Its total return/PE of 2.36 is more than 3x the industry average.
  • Nexstar Media Group (NXST): Nexstar owns television stations and websites across the U.S. It has a P/E of 13.3, 51% below market average. EPS have increased 18% and sales 9% per year over the past 3-5 years. Analysts expect 58% long-term growth. Its total return/PE is 1.68, more than double the industry average. Free cash flow is strong.
  • Berry Global Group (BERY): Berry makes plastic packaging products. Its P/E of 14.1 is 48% below the market. It has grown EPS 17% and sales 7% per year long term. Analysts expect 51% EPS growth this year and 9% long term. Its total return/PE is over 1.3, more than double the market average. Free cash flow is $6.50 per share.
  • Spire Inc (SR): Utility firm Spire’s 15.2 P/E is 44% below market average. Its EPS have grown 16.8% and sales 9% per year over past 3-5 years. Analysts expect 12% EPS growth this year and 6% long term. Its total return/PE is double the market average.

John Neff showed that a focus on low P/E stocks with good fundamentals could outperform the market over the long term. By using a quantitative model based on Neff’s approach, Validea is identifying stocks like DKS, NXST, BERY and SR that share the characteristics that made Neff so successful.

Research Links

More About John Neff

Validea’s John Neff Strategy