Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

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Allocations for October 2022 (Final)
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Fundamental Valuation

What fundamental measures of business success best indicate the value of individual stocks and the aggregate stock market? How can investors apply these measures to estimate valuations and identify misvaluations? These blog entries address valuation based on accounting fundamentals, including the conventional value premium.

Institutional Ownership, Idiosyncratic Volatility and Stock Returns

Is the number of institutional owners of a stock, arguably a proxy for general investor awareness and demand, an important factor in current and future pricing of the stock? In their February 2011 paper entitled “What Makes Stock Prices Move? Fundamentals vs. Investor Recognition”, Scott Richardson, Richard Sloan and Haifeng You investigate the role of institutional ownership breadth in size-adjusted stock price dynamics. They focus on institutional investors with greater than $100 million in equity holdings, as reported quarterly to the SEC via Form 13F. They measure institutional ownership breadth as the number of institutions holding a particular stock relative to the number of institutions holding any given stock. They measure firm size based on total assets. They impose a three-month lag on data to ensure calculations use only publicly available information. Using stock returns, institutional ownership data and accounting data for a broad sample of U.S. firms over the period 1986 through 2008 (35,526 firm years), they find that: Keep Reading

Concentrating the Value Premium and Momentum with FSCORE

Can financial statement analysis expose stocks that investors incorrectly view as value or growth (glamor)? In their February 2011 paper entitled “Identifying Expectation Errors in Value/Glamour Strategies: A Fundamental Analysis Approach”, Joseph Piotroski and Eric So investigate stock misvaluation by contrasting firm performance expectations implied by value/growth classification with a simple financial statement metric that differentiates improving versus deteriorating financial performance. This metric (FSCORE, scale 0 to 9), based on nine binary financial statement parameters, measures both the overall financial condition of a firm and the degree to which the firm has improved this condition over the prior year. The authors examine how FSCORE interacts with five widely used relative valuation metrics (book-to-market ratio, cash flow-to-price ratio, earnings-to-price ratio, sales growth and equity share turnover) and with momentum. Using annual financial data and stock returns for a broad sample of firms over the period 1972 through 2008 (117,412 firm-year observations), they find that: Keep Reading

Outperformance of Entrepreneurial Stocks

Is it feasible to isolate and exploit the value of entrepreneurial spirit among publicly traded stocks? In his Fall 2009 article entitled “Investing in Troubled Times: Entrepreneurs are Your Safest Bet”, Joel Shulman defines, filters and analyzes the performance of entrepreneurial stocks. Building on prior research, he defines “entrepreneurial” based on the following 15 attributes, several of which do not accommodate mechanical quantitative screening:

  1. Organic growth opportunities
  2. Above-average ownership stakes among key stakeholders
  3. Low selling, general, and administrative expenses
  4. Above average return on invested capital
  5. Sustainable growth
  6. Manageable debt
  7. Active strategic alliances/partnerships/licensing deals
  8. Aligned executive compensation packages
  9. Low executive turnover
  10. Transparent governance
  11. Long duration of key managers
  12. Low or no dividends
  13. Family involvement
  14. Strong earnings before interest, taxes, depreciation and amortization
  15. Other significant stakeholder relationships (such as key board members)

Using  information for 9,000 publicly traded firms worldwide for which sufficient financial, stock return and other data are available over the period January 1997 through August 2009, he finds that: Keep Reading

Corporate Leverage and Future Stock Returns

Is company financial leverage a useful indicator of future stock returns? In their October 2010 paper entitled “Would You Follow MM or a Profitable Trading Strategy?”, Brian Baturevich and Gulnur Muradoglu test company leverage (gearing ratio) as a predictor of stock outperformance, controlling for market capitalization, price-to-earnings ratio, market-to-book value ratio and beta. At the beginning of May each year, they construct ten equally weighted portfolios ranked on gearing ratio as of the end of the preceding December and hold the portfolios for three years. They further sort each of these portfolios into ten sub-portfolios ranked on controlling variables as of the end of the preceding December (creating 100 sub-portfolios). Using stock return and accounting data for 413 non-financial S&P 500 companies over the period May 1985 through April 2004, they find that: Keep Reading

Effects of Creeping Indexation?

What are the implications for investors of a trend toward strategic and tactical allocation to index proxies (exchange-traded funds and derivatives) rather than individual securities? The July 2010 paper entitled “On the Economic Consequences of Index-Linked Investing” by Jeffrey Wurgler provides an overview of the effects of index-linked investing on stock prices, risk-return trade-offs, investor portfolio allocation decisions and fund manager skill assessments. The September 2010 paper entitled “Index Investment and Financialization of Commodities” by Ke Tang and Wei Xiong investigates the effects of increased investing during the last decade in commodity indexes. The October 2010 paper entitled “The Financialization of Commodity Futures Markets or: How I Learned to Stop Worrying and Love the Index Funds” by Scott Irwin and Dwight Sanders surveys research on the impact of commodity index fund growth on commodity price behavior. Using results of prior research and recent data on indexation investment levels, index returns and component asset returns, these papers find that: Keep Reading

Volatility and Valuation with High-frequency Trading

Does high-frequency trading amplify noise and thereby reduce the signal-to-noise ratio in stock returns? In his August 2010 paper entitled “The Effect of High-Frequency Trading on Stock Volatility and Price Discovery”, Frank Zhang examines the effect of high-frequency trading on stock price volatility and on incorporation of fundamental news into price. He defines high-frequency trading as that driven by fully automated trading strategies with very high trading volume and extremely short holding periods ranging from milliseconds to minutes and possibly hours (typically not overnight). He estimates the volume of high-frequency trading as the residual after accounting for institutional and individual investor activities. Using price, trading and institutional holdings data for a broad sample of U.S. stocks from the first quarter of 1985 through the second quarter of 2009, he finds that: Keep Reading

Weak Guidance vs. Beating Consensus

Conventional wisdom is that company management can maximize stock price by issuing weak guidance for future earnings that sets low expectations, and then reporting earnings that beat the low expectations. Does evidence support this belief? In their September 2010 paper entitled “The Stock Price Effects from Downward Earnings Guidance Versus Beating Analysts’ Forecasts: Which Effect Dominates?”, Lynn Rees and Brady Twedt investigate the net effect on stock price of downward earnings guidance that enables a subsequent positive earnings surprise. Using a sample of 8,635 guidance-earnings observations for 2,751 firms during 1993 through 2006, along with a matched control sample, they find that: Keep Reading

Combining Momentum and Asset Growth

Both stock price momentum and asset growth rate exhibit empirical value as return predictors for individual stocks. Does combining these indicators offer enhanced value to investors? In their September 2010 paper entitled “Firm Expansion and Stock Price Momentum”, Peter Nyberg and Salla Pöyry investigate the interaction between firm-level asset growth (change in balance sheet total assets) and stock price momentum. Specifically, they measure returns for a monthly strategy that buys (sells) the prior winners (losers) within groups of stocks sorted first on on asset growth rates and then on 11-month past returns with skip-month. Using data for a broad sample of U.S. firms listed on NYSE, AMEX and NASDAQ over the period 1964-2006, they find that: Keep Reading

Market Models Summary Augmentation

Two charts added to “Market Models”, a backtest of the 6-month forecasts and a current valuation map, offer context for the projections from the Reversion-to-Value (RTV) Model and the Real Earnings Yield (REY) Model of the U.S. stock market.

Simple Versus Complex Valuation Metrics

Do complex valuation metrics outperform simple ones in predicting stock returns? In their July 2010 paper entitled “The Sophisticated and the Simple: The Profitability of Contrarian Strategies from a Portfolio Manager’s Perspective”, Daniel Giamouridis and Chris Montagu compare and contrast several simple and sophisticated valuation metrics, with focus on those of interest to equity portfolio managers. They consider three simple metrics: (1) forward price-earnings ratio (PE); (2) Book Yield (book price per share divide by share price); and, (3) Fair PE, derived from expected earnings growth and market capitalization. They consider sophisticated metrics as generated by two models: (1) the Residual Income Model (RIM), a function of current book value plus residual income; and, (2) the real options model (ROM), a convex function of earnings and book value. Using monthly firm fundamentals and return data for approximately 450 stocks that have been or are constituents of the MSCI Europe Index during January 1990 to April 2010, they find that: Keep Reading

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