Fundamental Valuation

Do aggregate corporate earnings predict bond market returns? In his January 2012 paper entitled “Aggregate Earnings and Corporate Bond Markets”, Xanthi Gkougkousi investigates the relationship between aggregate earnings and corporate bond market returns. Using quarterly aggregate earnings for a broad sample of U.S. stocks with fiscal years ending in March, June, September and December and total quarterly returns for ten U.S. corporate bond indexes during January 1973 through December 2010 (360,614 firm-quarter observations), he finds that: More…

We have updated the Market Models summary as follows:

• Extended the Earnings Forecast through the end of 2012 based on an estimate of actual earnings for the fourth quarter of 2011.
• Extended regressions/rolled projections by one month based on data available through January 2012.
• Updated backtest charts and the market valuation metrics map based on data available through January 2012.

We have updated the six-month lagged momentum asset class, sector and style ETF winners for January 2012 on the home page.

We have updated the Trading Calendar to incorporate data for January 2012.

Are realized (actual historical) and implied volatilities the whole story for equity option valuation? In their December 2011 paper entitled “Fundamental Analysis and Option Returns”, Theodore Goodman, Monica Neamtiu and Frank Zhang investigate the extent to which the equity options market fails to recognize volatility of firm operations (accounting data) and whether any such failure is exploitable. They focus tests on long, one-month-to-expiration, at-the-money straddles (long both a call and a put), which profit from large moves in underlying stock prices. They estimate future volatility in firm fundamentals via regression based on a combination of short-term sales/earnings growth and long-term sales/earnings growth volatility (standard deviation over the last six years). They isolate a “pure” expected fundamental volatility via regression versus implied volatility and the implied-realized volatility gap. Using data as available to estimate the relationship between fundamental volatility and returns on options for individual U.S. stocks during January 1996 through September 2010 (52,251 firm-quarters involving 3,481 distinct firms), they find that: More…

We have updated the details of the  the Reversion-to-Value (RTV) Model and the Real Earnings Yield (REY) Model of the U.S. stock market to incorporate data available through December 2011.

Which widely used valuation metric is best for picking individual stocks? In their November 2011 paper entitled “Analyzing Valuation Measures: A Performance Horse-Race over the past 40 Years”, Wesley Gray and Jack Vogel compare the performances of five annually reformed portfolios sorted on different valuation ratios: earnings-to-market capitalization (E/M); earnings before interest, taxes, depreciation and amortization-to-total enterprise value (EBITDA/TEV); free cash flow-to-total enterprise value (FCF/TEV); gross profit-to-total enterprise value (GP/TEV); and, book value-to-market capitalization (B/M). They also compare the performances of ratios calculated with one year of earnings versus averages of annual earnings over the past two to eight years. They include a lag of at least three months between firm reporting interval and return calculation interval. Using stock price and firm fundamentals data for NYSE common stocks with at least eight years of history (excluding financial, utilities and the 10% of stocks with the smallest market capitalizations) during July 1971 through December 2010, they find that: More…

Do analysts who work for hedge funds make good calls? In their November 2011 paper entitled “Do Buy-side Recommendations Have Investment Value?”, Steven Crawford, Wesley Gray, Bryan Johnson and Richard Price III profile analysts employed by mutual funds, hedge funds and other investment firms and examine whether these experts make good trading recommendations. Using personal data and 2,135 long and short U.S. common stock investment propositions from over 1,100 participants in the SumZero community of buy-side investment professionals (mostly associated with hedge funds) during March 2008 through December 2010, and contemporaneous institutional holdings from SEC Form 13F filings, they find that: More…

James O’Shaughnessy (Chairman and CEO of O’Shaughnessy Asset Management) introduces his 2011 book, What Works on Wall Street (Fourth Edition): the Classic Guide to the Best-Performing Investment Strategies of All Time, by stating: “…investors seem programmed by nature to fail at investing, forever chasing the asset class that has turned in the best performance recently and heavily discounting anything that occurred more than three to five years ago. The whole purpose of What Works on Wall Street is to dissuade investors from that course of action. Only the fullness of time shows which investment strategies are the best long-term performers, and this is doubly true after the last decade’s sorry performance. …We will make the case that equities–particularly those selected using the best long-term strategies–will go on to be the best performing assets over the next 10 and 20 years. …The fourth edition of What Works on Wall Street continues to offer readers access to long-term studies of Wall Street’s most effective investment strategies.” He uses overlapping portfolios formed monthly and rebalanced annually for all tests. Using broad sets of data on U.S. firms/stocks from either 1963 or 1926 through 2009 to extend and expand his prior quantitative analyses, he concludes that: More…

In the mid-1990s, James O’Shaughnessy identified “cornerstone value” and “cornerstone growth” as best-of-breed equity investment strategies. The former emphasizes dividends among large-capitalization stocks, and the latter momentum/earnings growth for a broader universe. Based on Standard and Poor’s Compustat data, he found that the value (growth) strategy returned an average 15% (18%) per year over a backtesting period of 1952-1994, compared to 8.3% for the S&P 500 Index. He implemented these two strategies in late 1996 via mutual funds and publicized them in early editions of his book What Works on Wall Street: A Guide to the Best-Performing Investment Strategies of All Time. He subsequently sold the mutual funds (which apply slightly different portfolio formation rules from those specified in the original research) to Hennessy Funds in 2000, where they survive as the Hennessy Cornerstone Value Fund (HFCVX) and the Hennessy Cornerstone Growth Fund (HFCGX). Has 14 years of out-of-sample performance of these two mutual funds confirmed the motivating backtests? Using self-reported annual total returns for HFCVX, HFCGX and selected benchmark indexes during 1997 through 2010, we find that: More…

To determine whether the stock market is expensive or cheap, some experts use aggregate valuation ratios, either trailing or forward-looking, such as price-earnings ratio (P/E) and price-dividend ratio. Operating under a belief that such ratios are mean-reverting, most imminently due to movement of stock prices, these experts expect high (low) future stock market returns when these ratios are low (high). Where are the ratios now? Using the S&P 500 Index level as of the close on 11/22/11 and the most recent actual and forecasted earnings and dividend data from Standard & Poor’s, we find that: More…

Do investors focus on dividends, thereby elevating associated stock prices as ex-dividend date approaches? In the September 2011 draft of their paper entitled “The Dividend Month Premium”, Samuel Hartzmark and David Solomon examine the price behavior of stocks with scheduled quarterly, semiannual and annual dividends during the expected dividend month and around expected ex-dividend dates. Using daily and monthly price and cash dividend data for a broad sample of U.S. stocks during January 1927 through December 2009, along with widely used risk adjustment factors, they find that: More…