Value Premium

Does the relatively illiquid, opaque, retail environment of over-the-counter (OTC) stocks make them behave differently from comparable listed stocks? In their November 2010 paper entitled “The Cross Section of Over-the-Counter Equities”, Andrew Ang, Assaf Shtauber and Paul Tetlock test the abilities of market capitalization, book-to-market ratio, liquidity, return momentum and idiosyncratic volatility to predict OTC stock returns and compare results to those for listed stocks with comparable market capitalizations. As a part of the study, they examine hedge portfolios that are long/short extreme fifths of OTC stocks ranked by these characteristics to estimate of the magnitudes of the respective  premiums. Using trading volumes, market capitalizations, book-to-market ratios (as available) and closing, bid and ask prices for a large sample of OTC-only firms with at least one Financial Industry Regulatory Authority market maker, and for comparable listed firms, during 1975 through 2008, they find that: More…

Market capitalization is the most frequently used metric for weighting the individual stock components of market indexes. Other approaches range from equal weighting to weighting on firm fundamentals to weighting generated by return-risk optimization. How do such alternative metrics work empirically? In the October 2010 draft of their paper entitled “A Survey of Alternative Equity Index Strategies”, Tzee-man Chow, Jason Hsu, Vitali Kalesnik and Bryce Little examine several popular passive index weighting alternatives to market capitalization. They impose common assumptions to backtest these alternatives on U.S. and global equity data over long periods with either annual or quarterly rebalancing. They also apply the Fama-French three-factor model to investigate sources of outperformance relative to capitalization-weighted benchmarks. Using stock/firm data for the 1,000 largest global firms spanning 1987-2009 and for the largest 1,000 U.S. firms spanning 1964-2009, they find that: More…

Do value and momentum strategies work in the least mature equity markets? In the September 2010 update of their paper entitled “Value and Momentum in Frontier Emerging Markets”, Wilma de Groot, Juan Pang and Laurens Swinkels examine whether the value premium based on book-to-market ratio (B/M), earnings-to-price ratio (E/P) or dividend-to-price ratio (D/P) and the momentum effect exist in frontier equity markets. Their basic methodology is to form long-short portfolios of equally weighted extreme (most and least attractive) quintiles monthly and to hold each portfolio for six months, with monthly outcomes calculated as averages for the six active portfolios (in excess of U.S. Treasury bills). Using return and accounting data for over 1,400 S&P Frontier Broad Market Index stocks  from 24 of the most liquid frontier markets over the period January 1997 through November 2008, they find that: More…

Is there a simple way to identify and exploit relative differences in the values of emerging equity markets? In their September 2010 paper entitled “New Evidence on Value Investing in Emerging Equity Markets”, Zhipeng Yan and Yan Zhao define and test value investing strategies that compare a country’s weight among a set of emerging markets based on value (GDP, earning-price ratio or dividend yield) to its weight based on stock market capitalization. Specifically, they construct and rebalance quarterly a portfolio of emerging markets stock indexes with weights equal to value-capitalization weight deltas. They consider also a simple alternative portfolio similarly constructed from equal-capitalization weight deltas. If the delta for a country is positive (negative), the position in that country’s index is long (short), such that the overall portfolio is neutral. Using quarterly GDP measurements, monthly earnings-to-price ratio and dividend yield data and monthly dollar-denominated total stock index returns for 23 emerging markets spanning 1995-2008, they find that: More…

Studies of the U.S. stock market indicate that some factors and indicators may have predictive power for future returns. Do these findings consistently translate to other large equity markets? In the July 2010 version of their paper entitled “The Cross-Section of German Stock Returns: New Data and New Evidence”, Sabine Artmann, Philipp Finter, Alexander Kempf, Stefan Koch and Erik Theissen apply a new set of single-sorted and double-sorted factor portfolios based on market beta, size, book-to-market ratio and momentum to test for beta effect, size effect, value premium and momentum in the German equity market. In the July 2010 version of their paper entitled “The Impact of Investor Sentiment on the German Stock Market”, Philipp Finter, Alexandra Niessen-Ruenzi and Stefan Ruenzi test the predictive power of a composite sentiment measure combining consumer confidence, net equity mutual funds flow, put-call ratio, aggregate trading volume, initial public offering (IPO) returns, number of IPOs and aggregate equity-to-debt ratio of new issues. Using data for 955 non-financial German firms for which sufficient data is available during the period 1960-2006 for the factor portfolios and 1993-2006 for the sentiment measure, these studies find that: More…

Is level of profitability alone, and in combination with other firm/stock characteristics, a useful indicator of future stock returns? In his April 2010 paper entitled “The Other Side of Value: Good Growth and the Gross Profitability Premium”, Robert Novy-Marx investigates the power of the gross profits-to-assets ratio to predict returns for individual stocks as a standalone indicator and in combination with the book-to-market ratio. Using annual firm characteristics and stock price data for a broad sample of U.S. companies spanning 1962-2009, he concludes that: More…

Does designated creditworthiness, closely related to riskiness, drive the performance of many widely acknowledged stock return anomalies? In the April 2010 revision of their paper entitled “Anomalies and Financial Distress”, Doron Avramov, Tarun Chordia, Gergana Jostova and Alexander Philipov use portfolio sorts and regressions to investigate the relationship between financial distress (low credit ratings and downgrades) and profitability for trading strategies based on: stock price momentum, earnings momentum, credit risk, analyst earnings forecast dispersion, idiosyncratic volatility, asset growth, capital investments, accruals and value. Using data for broad samples of U.S. stocks (limited by extensive information requirements) spanning October 1985 through December 2008, they conclude that: More…

Reader Jeff Partlow observed: “As a value investor, Mohanram’s study is somewhat comforting.

Mohanram: Growth stocks on average underperform. Mohanram’s methodology outperforms within this subset.   Net Result: Underperform x Outperform = Relative Mediocrity

Piotroski: Value stocks on average outperform. Piotroski’s methodology outperforms within this subset.  Net Result: Outperform x Outperform = Relative Excellence

Conclusion:  Again, as virtually always:  be a value-oriented investor.” More…

A reader observed and asked: “There are two strategies, both of which appear to work, but which also seem contradictory to each other. Momentum says what goes up must go up further. Reversion says what goes up must come down. Both work? There must be something wrong here?!? More…

Are stock earnings yield (E/P) and firm book-to-price ratio (B/P) complementary indicators of future stock returns? In their December 2009 paper entitled “Returns to Buying Earnings and Book Value: Accounting for Growth and Risk”, Francesco Reggiani and Stephen Penman investigate the interplay of E/P and B/P in an accounting context, including joint implications for future stock returns. The authors hypothesize that B/P measures the degree to which firms defer recognition of risky earnings. Using monthly stock return and firm financial data for a broad sample of U.S. stocks spanning 1963-2006 (153,858 firm-years over 44 years), they find that: More…