Genius, a wise man once said, is nothing but a great aptitude for patience.

This is certainly true about Value Line: After a number of years during which Value Line’s famed stock ranking system struggled, 2005 was a big win.

This vindicated Value Line’s belief in the continued value of its ranking system and, as well, serves as a reminder to all of us to have the patience and discipline to stick with systems that have great long-term records but that are experiencing shorter-term periods during which they are out of synch with the market.

Value Line (TICKER:VALU) was founded in the 1930s by Arnold Bernhard. It is perhaps best known on Wall Street for its stock-ranking system, which has been published weekly since 1965, more than 40 years ago, in its flagship newsletter, The Value Line Investment Survey.

Each week, Value Line segregates 1,700 of the most widely followed stocks into five categories according to their perceived performance prospects for the coming 6 to 12 months. Group 1 contains the stocks thought to have the best potential while Group 5 contains those considered the worst prospects.

The performance of Value Line’s stock picks has been good enough to impress even skeptical academics. In fact, its track record during its first few years was so exceptional that a prominent finance professor, who had famously gone on record declaring that the market could not be beaten, conceded that the Value Line stock-ranking system constituted an exception.

The professor was the late Fischer Black, who, at the time, was a professor at the University of Chicago. (He subsequently taught at MIT and then went to work on Wall Street; he is perhaps best known today as the co-author of the Black Scholes options valuation model.) In a 1973 article in the Financial Analysts Journal, entitled "Yes, Virginia, There is Hope," Black reported on his analysis of the Value Line ranking system's performance.

Noting that most Wall Street firms’ stock picks lag the market, while Value Line's ranking system had shown ability to beat it, Black concluded, “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.”

But, no stock-picking system works equally well at all phases of the market cycle, and Value Line’s ranking system is no exception. Particularly agonizing for followers of Value Line was the performance of its ranking system over the four years from 2001 through 2004, during each of which, Value Line’s Group 5 stocks outperformed its Group 1 stocks -- just the opposite of what Value Line had forecasted.

This led some to conclude that its ranking system had stopped working, a victim of its own success. This is a perennial worry with strategies that become popular, after all, because no system -- no matter how good -- will continue to work if too many investors start following it.

Throughout it all, Value Line kept the faith. Samuel Eisenstadt, the 82-year-old research chairman at Value Line, who had spearheaded the original research in the 1950s and 1960s that led to the ranking system’s creation, repeatedly pointed out that the ranking system had gone through rough patches before and, on each of those occasions, had eventually reverted to form.

And, while acknowledging that there is no guarantee that the system will work forever, especially if it becomes too popular, Eisenstadt, nevertheless, insisted that probabilities favored the ranking system working again.
Eisenstadt was right, at least about 2005. According to the Hulbert Financial Digest’s calculations, a portfolio would have gained 10.3 percent in 2005 by always remaining invested in the stocks ranked highest by Value Line. (Note carefully that this 10.3 percent takes into account bid-ask spreads, as well as discount brokerage commissions.)

Not only is this 10.3 percent well ahead of a portfolio of Value Line’s Group 5 stocks, it also is significantly ahead of the major market averages. The total market value of all publicly traded stocks, as measured by the Dow Jones Wilshire 5000 index (TICKER:$DWC), gained 6.3 percent last year. The S&P 500 (TICKER:$SPX) produced a total return of 4.9 percent; the Dow Jones Industrials Average (TICKER:$INDU) 1.7 percent.

Mark can be contacted via email at mhulbert@marketwatch.com.