Article2007

Value enhancement using momentum indicators: the European experience

27 citations0/0 files storedInternational Journal of Managerial Finance

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Financial Markets and Investment Strategies Financial Analysis and Corporate Governance Financial Reporting and Valuation Research

Abstract

Purpose - The purpose of this research is to study the extent to which various price and earnings momentum measures can be used to enhance portfolio performance by better timing entry into value stocks (and isolating those growth stocks that still have some period to run). Design/methodology/approach - The paper uses the traditional methodology of ranking stocks on the basis of certain value and momentum measures (e.g. book-to-market, market return over some prior period), forming portfolios based on these rankings which are held for a specific period of time. The portfolios are formed on the basis of a single measure of multiple measures and the returns and associated p-values are calculated with the objective of determining how these portfolios perform relative to a benchmark portfolio composed of all the companies in the universe. The analysis is conducted on a database consisting of approximately 8,000 companies drawn from 15 European countries over the period from January 1989 to May 2004. Findings - It was found that a number of individual, and combinations of, price and earnings momentum factors are able to enhance value portfolios by identifying stocks that will not perform well in the immediate future. The best measure that was found for timing entry into value and growth stocks is a combination of price momentum and price acceleration where the difference in monthly performance between the "best" and "worst" value (growth) portfolios is 2.6 percent (2.4 percent) for holding periods of 12 months. It was found not only that this momentum measure can be used to enhance value and growth in portfolios consisting of all European stocks but also that it can be successfully deployed in the major individual markets and regions. Originality/value - Most studies that evaluate the performance of value and growth portfolios do not consider the characteristics of the stocks held in these portfolios. However, it is these characteristics that determine the success of the portfolios formed on the basis of what can only be described as very crude valuation multiples. This paper demonstrates the potential of a closer evaluation of the stocks chosen to be included in a particular portfolio by being able to identify those stocks most likely to perform (and under-perform). The findings in the paper have obvious implications for the investment processes of investment managers but they also provide useful insights into the efficiency of the European markets and the typical means of price formation within those markets. © Emerald Group Publishing Limited.

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References

1993Common risk factors in the returns on stocks and bonds 1964CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK*1992The Cross-Section of Expected Stock Returns 1993Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency 1965The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets 1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]1996Multifactor Explanations of Asset Pricing Anomalies

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