Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for September 2023 (Final)

Momentum Investing Strategy (Strategy Overview)

Allocations for September 2023 (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.

A Few Notes on The Little Book of Behavioral Investing

In his 2010 book entitled The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy, author James Montier states: “I…highlight some of the most destructive behavioral biases and common mental mistakes that I’ve seen professional investors make. I’ll teach you how to recognize these mental pitfalls while exploring the underlying psychology behind the mistake. Then I show you what you can do to try to protect your portfolio from their damaging influence on your returns.” Biases he surveys include: action bias, bias for stories, confirmation bias, conformity bias (herding or groupthink), conservatism (including sunk cost fallacy), disposition effect, empathy gap, endowment effect, hindsight bias, illusion of control, inattentional blindness, information overload, loss aversion, myopia, overconfidence, overoptimism, placebo effect, self-attribution bias and self-serving bias). Value investing provides the context for discussion. Citing a number of studies, he concludes that: Keep Reading

Refining the Accrual Anomalies

Are there ways to concentrate the predictive power of accruals for future individual stock and equity market returns? Two recent papers explore potential refinements. In the January 2010 draft of their paper entitled “Predicting Stock Market Returns with Aggregate Discretionary Accruals”, Qiang Kang, Qiao Liu and Rong Qi focus on whether aggregate discretionary accruals (distinguished from normal accruals) are a better predictor of stock market returns than aggregate total accruals. In their February 2010 paper entitled “Percent Accruals”, Nader Hafzalla, Russell Lundholm and Matt Van Winkle investigate scaling firm-level accruals by earnings rather than total assets to predict returns for individual stocks. These studies conclude that: Keep Reading

Preliminary Test of RYT Model Daily Valuations

Since 7/9/09, Christophe Faugère has been publishing (almost) daily “Market Estimates” of the value of the S&P 500 Index based on Required Yield Theory (RYT). RYT views investors as: (1) requiring that U.S. stocks and bonds in aggregate prospectively provide a real after-tax yield directly related to real long-term GDP per capita growth; and then, (2) deciding between stocks and bonds based on the better after-tax real return. To test the predictive power of these market estimates, we focus on daily percentage mismatches between estimated and actual values of the S&P 500 Index [(Estimated-Actual)/Actual] and exploitability of these mismatches via S&P Depository Receipts (SPY). Using daily RYT market estimates and daily levels of the S&P 500 Index and SPY over the period 7/9/09 through 3/3/10 (160 daily model outputs), we find that: Keep Reading

Combining E/P and B/P

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: Keep Reading

Deconstructing Effects of Corporate News

What types of corporate news have the most impact on stock price? In their February 2010 paper entitled “Market Reaction to Corporate News and the Influence of the Financial Crisis”, Andreas Neuhierl, Anna Scherbina and Bernd Schlusche analyze immediate stock return, volatility and liquidity reactions to various types of corporate news (focusing on one day before to five days after release date). They segment news releases into nine major categories and 52 subcategories. Using a comprehensive sample of 285,917 corporate press releases carried by all major news wire services between April 2006 and August 2009, they find that: Keep Reading

Momentum vs. Value

A reader asked: “Have you done any backtesting to compare value investing versus market timing? Magic Formula Investing seems to rank #1 in value investing and Decision Moose seems to stand out for market timing. Is there any direct comparison between Magic Formula Investing vs. Decision Moose?” Keep Reading

Long-term Trends and Short-term Variations in Valuation Ratios

Does decomposition of widely used valuation ratios into components that reflect long-term trend and shorter-term variation from trend reveal predictability? In their November 2009 paper entitled “Do Decomposed Financial Ratios Predict Stock Returns and Fundamentals Better?”, Xiaoquan Jiang and Bong-Soo Lee explore decomposition of the dividend-price, earnings-price and book-to-market ratios into stochastic trend and cyclical components. The stochastic trend component measures variations in longer-term trend (fundamental structural changes), while the cyclical component measures shorter-term deviations from this trend. The study employs rolling four-quarter sums of dividends and earnings, with the latter smoothed via a ten-year moving average, and accounting data to model older book values. Using quarterly S&P 500 Index returns and valuation metrics for the S&P 500 over the period 1926-2008, they find that: Keep Reading

Earnings Surprises and Future Stock Market Returns

As espoused by many market commentators, do positive (negative) earnings surprises in fact predict upward (downward) stock market movement? In their January 2010 paper entitled “Aggregate Market Reaction to Earnings Announcements”, William Cready and Umit Gurun investigate the relationship between earnings announcement surprises and market returns, focusing on the days surrounding earnings news. Using quarterly earnings announcements for a broad sample of firms spanning January 3, 1973 through June 21, 2006 (413,687 announcements) and contemporaneous values of a combined NYSE/AMEX index, they find that: Keep Reading

Are Zacks Rankings Exploitable?

A reader inquired about the Zacks services. The core belief of Zacks Investment Research is: “Earnings estimate revisions are the most powerful force impacting stock prices.” This belief underlies the Zacks “quantitative model to harness the power of earnings estimate revisions – the direction, the degree of change, and surprises – along with other important variables to create the Zacks Rank.” The Zacks Rank feeds a range of information services that Zacks offers to investors. Should investors expect that portfolios built on the Zacks Rank will substantially outperform the market? Based on information available about the Zacks Rank and associated managed accounts/funds, we find that: Keep Reading

Volatility and Valuation Ratios

Conventional wisdom holds that a low market valuation ratio and a high market volatility both relate positively to future market return. Do valuation ratio and volatility therefore relate negatively to each other with some consistency? If not, why not? In their November 2009 paper entitled “What Ties Return Volatilities to Price Valuations and Fundamentals?”, Alexander David and Pietro Veronesi investigate the relationships between stock and bond valuations and their volatilities in the context of varying investor beliefs about future economic growth and inflation. Using S&P 500 operating earnings from Standard & Poor’s, daily closes of the S&P 500 Index, daily bond yield/return data and monthly values of the Consumer Price Index over the period 1958 through 2008 (51 years), they conclude that: Keep Reading

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