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Investing Research Articles

Global Diversification: By Country or Industry?

With increasing business globalization and financial markets integration, can equity investors still get good risk reduction by diversifying their portfolios across country markets? Or, have other kinds of diversification become more important? In their paper entitled “The Changing Roles of Industry and Country Effects in the Global Equity Markets”, Kate Phylaktis and Lichuan Xia examine the evolution of country and industry effects on stock returns and diversification. Using weekly returns from the Dow Jones Global Indexes (DJGI) encompassing 4,801 companies in 51 industry groups across 34 countries over the period 1992 to 2001, they find that: Keep Reading

Earnings, Inflation and Stock Returns

In their February 2003 paper entitled “Stock Returns, Aggregate Earnings Surprises, and Behavioral Finance”,  Jonathan Lewellen, S. Kothari and Jerold Warner explore the relationships between overall stock market behavior and aggregate corporate earnings, looking for parallels with firm-level price-earnings behavior. Using quarterly data for 1970-2000, they conclude that: Keep Reading

The Odds of Winning as an Active Trader

How active are active traders? What are the odds that an active trader will make a profit? How are winners different from losers? In their recent paper entitled “The Profitability of Active Stock Traders”, Ryan Garvey and Anthony Murphy examine the outcomes for a large group of active traders over a three-month period. Using data for over 400,000 trades by 1,386 day traders from a direct access broker in the U.S. over the period March 8, 2000 through June 13, 2000 (68 trading days), they find that: Keep Reading

Diversification for “Peak” Performance

How many stocks are enough for the long-term investor to diversify stock-picking risks? Conventional wisdom says that 8 to 20 stocks are enough. In their recent paper entitled “Diversification in Portfolios of Individual Stocks: 100 Stocks Are Not Enough”, Dale Domian, David Louton and Marie Racine examine the risk that long-term buy-and-hold stock portfolios will fall short of some minimum return goal. They use portfolios of different sizes constructed from a real sample of 1,000 U.S. stocks (the 100 largest by market capitalization in each of 10 industries) over the 20-year period from January 1985 through December 2004, inserting comparable replacements for the hundreds of delistings that occur in the sample (mostly due to mergers). They find that: Keep Reading

Training for the Investor/Trader Hurdles

Investors and traders face three hurdles on the track to success: (1) developing a workable strategy/methodology as a foundation for decision-making; (2) persistently performing the research needed to reconfirm/improve/adapt the strategy; and, (3) overcoming emotional temptations to ditch strategy and research by succumbing to fear or greed.  Keep Reading

Why Highly Volatile Stocks Tend to Underperform

Conventional wisdom holds that: (1) risk begets reward; and, (2) volatility is a manifestation of risk. Exceptionally high volatility in individual stock prices should, therefore, indicate future excess returns in those stocks. In their May 2006 paper entitled “The Relation between Time-Series and Cross-Sectional Effects of Idiosyncratic Variance on Stock Returns in G7 Countries”, Hui Guo and Robert Savickas investigate why the realized idiosyncratic volatility (beta) of individual stocks correlates negatively with future returns — why there is a penalty instead of a reward for this apparent risk. Using two sets of U.S. data (1926-2005 and 1963-2005) and one set of international data (1973-2003), they conclude that: Keep Reading

Capturing the Value Premium by Avoiding Institutional Ownership

Which cheap (high book-to-market value) stocks drive the value premium? Can investors capture the value premium by simply buying a broad index of value stocks, or should they focus on some easily identifiable subset. The paper “Institutional Ownership and the Value Premium” by Ludovic Phalippou from April 2005 evaluates level of institutional ownership as the driver of the value premium, hypothesizing that mispricing of stocks is mostly like to come from unsophisticated individual investors. Using data for 1980-2001, he concludes that: Keep Reading

Market-Leading Industries

Do certain industries tend to lead or lag stock market cycles? In the November 2004 update of their paper entitled “Do Industries Lead the Stock Market?”, Harrison Hong, Walter Torous and Rossen Valkanov investigate whether returns from some industries predict future returns for the overall stock market. The authors hypothesize that the overall market only gradually recognizes valuable information contained in the returns of specific industries. Using U.S. data for 1946-2002 and international data for 1973-2002, they conclude that: Keep Reading

Do What the Company Does?

The most informed investors in a firm’s stock are the executives and board members of the company. They have access to more, and more current, private information than anyone else. Do their actions in buying or selling equity or debt on behalf of the company reliably indicate its concurrent stock valuation? Do financial analysts accurately interpret these signals for investors? In the June 2005 update of their paper entitled “The Relation Between Corporate Financing Activities, Analysts’ Forecasts and Stock Returns”, Mark Bradshaw, Scott Richardson and Richard Sloan investigate the relationships among: (1) a simple cash flow-based measure of corporate financing activities; (2) analyst reactions to these activities; and, (3) stock returns. Corporate financing activities include selling and buying back of common stock, preferred stock, convertible debt, subordinated debt, notes payable, debentures and capitalized lease obligations. Using financial data spanning 1971-2000 and analyst forecast data spanning 1975-2000, they conclude that: Keep Reading

Combining Momentum and Value for Industry Rotation

Value and momentum are two very different equity investing styles, both with many adherents. Neither outperforms the overall market all the time. Is there some systematic way of combining these two approaches to enhance consistency of outperformance in global equity markets? In their March 2006 paper entitled “Generating Excess Returns through Global Industry Rotation”, Geoffrey Loudon and John Okunev examine different investing styles (momentum, value, combination of value and momentum, and growth) to exploit cyclic industry returns, with the U.S. yield curve as the critical economic indicator. Using monthly global prices, dividends, earnings and returns data for 36 industries for 1973-2005, they conclude that: Keep Reading

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