Backward-looking value driver performance after omitting the micro-caps

that high growth companies tend to be overpriced on the markets. The value companies provided significantly higher stock returns in the long-run. In this study, historical earnings growth shows no potential as a backward-looking value driver, because the value driver does not create any kind of buy vs. sell returns in one way or another. The difference between buy and sell portfolio is statistically insignificant with all common significance levels. The returns are oddly distributed, because the highest average returns are with the buy and the sell portfolios, but the highest median return is with the hold portfolio. Also the size peaks at the hold portfolio, and therefore, the value driver is tested also after omitting the micro-caps.

The D/E ratio creates a small positive hedge return in this sample, but the level of performance is significantly below the P/B or P/E ratios. This is in line with the previous studies as mentioned in section 2.3. However, the value driver has difficulties in creating any kind of difference between the median returns. All in all, the value driver shows relatively low performance as backward-looking value driver and its capability of capturing forward-looking information is very weak as well. Therefore, it is excluded from the following phases of the study.

Table 8 Backward-looking value driver performance after omitting the micro-caps

Sell Reduce Hold Accum. Buy All

Buy vs.

Sell N

P/B

Average Return 17% 17% 20% 21% 24% 20% 6.9% 2338

Median Return 7% 10% 12% 14% 16% 9.5%

Average Size 3258 2183 1484 1067 728 1744 -347%

Average P/B 16.29 2.87 1.88 1.31 0.73 4.62

Buy vs. Sell Diagnostis % of Max t-stat diff. in averages

5.3% 8.99*** 6.9%

P/E

Average Return 17% 17% 18% 20% 23% 19% 6.7% 1866

Median Return 7% 11% 13% 15% 18% 10.6%

Average Size 2293 2823 2395 1797 1320 2126 -74%

Average P/E 156.06 22.05 15.39 11.51 6.42 42.28

Buy vs. Sell Diagnostis % of Max t-stat diff. in averages

5.8% 6.26*** 4.9%

PEG

Average Return 16% 18% 19% 19% 21% 19% 5.3% 1108

Median Return 11% 14% 14% 13% 15% 3.6%

Average Size 4586 3241 2093 1908 1432 2652 -220%

Average PEG 9.74 0.91 0.49 0.24 0.07 2.29

Buy vs. Sell Diagnostis % of Max t-stat diff. in averages

4.8% 5.7*** 4.7%

P/RI¹

Average Return 17% 17% 18% 20% 23% 19% 6.5% 1440

Median Return 8% 11% 13% 16% 17% 8.5%

Average Size 2204 3452 3034 2365 1612 2533 -37%

Average P/RI 361.87 41.64 27.20 19.28 10.17 92.03

Buy vs. Sell Diagnostis % of Max t-stat diff. in averages

5.7% 5.4*** 4.8%

ROE

Average Return 21% 20% 20% 19% 20% 20% -0.4% 2323

Median Return 7% 12% 14% 13% 12% 5.4%

Average Size 574 1071 1562 2287 3300 1759 83%

Average ROE -0.80 0.06 0.13 0.19 0.73 0.06

Buy vs. Sell Diagnostis % of Max t-stat diff. in averages

-0.3% -1.72* -1.6%

Similar calculation methods as in Table 7, but now the bottom 20th percentile of smallest stocks in terms of market capitalization (micro-caps) have been omitted from the sample.

Value Driver

1 RI is estimated as (EBIT*1-0.35) - Invested Capital * 0.07.

* significant at 10% level, ** 5% and *** 1%

The most dramatic effect after omitting the micro-caps is the decrease in the performance of the P/B ratio. The P/B ratio was the most heavily size-correlated value driver. Thus, its performance almost halves after omitting the micro-caps. This is logical after considering the high returns related to micro-caps shown in section 3.3.2. The hedge return decreases to 6.9%, but still remains statistically significant. The hedge margin calculated using median does not fall as much as the average hedge margin, which implies that the micro-caps also included stocks that distorted the results through extreme stock returns. The P/B ratio still remains correlated with market capitalization even after omitting the micro-stocks. However, as we saw in section 3.3.2 omitting the micro-caps is enough to eliminate most of the size effect. To validate this the performance of the P/B ratio is calculated omitting bottom 50^thpercentile, and the results are reported in Table 9. The average hedge return drops only an additional 2% and the median hedge return stays almost the same. Indeed, the micro-cap omission seems to be enough to eliminate most of the size effect. As a conclusion, the P/B ratio seems to be relatively good backward-looking value driver even without the size effect.

Table 9 Performance of the backward-looking P/B ratio after omitting micro- and small-caps

Sell Reduce Hold Accum. Buy All

Buy vs.

Sell N

P/B

Average Return 15% 14% 17% 18% 20% 17% 4.7% 1574

Median Return 8% 10% 12% 13% 16% 8.1%

Average Size 4364 3185 2110 1680 1305 2529 -234%

Average P/B 12.79 3.13 2.06 1.43 0.83 4.05

Buy vs. Sell Diagnostis % of Max t-stat diff. in averages

4.2% 3.96*** 3.5%

Value Driver

Similar calculation methods as in Table 7, but now the bottom 50th percentile of smallest stocks in terms of market capitalization (micro-caps) have been omitted from the sample.

The P/E ratio does not suffer from the size-effect as much as the P/B ratio, which can be seen in Table 8. After omitting the micro-caps the performance of the P/B and P/E ratio are very close to each other. Actually in terms of median hedge return the P/E ratio is already better backward-looking value driver. ROE is the last value driver, where significant changes can be seen after omitting the micro-caps. When using the full sample this value driver produced

significant negative hedge returns. After omitting the micro-caps the average hedge return is practically zero. This indicates that the negative hedge return was mostly due to the strong size-effect in the driver. The larger companies tended to have higher ROE values than the smaller companies. As a conclusion, however, ROE shows no potential as a backward-looking value driver, because it is incapable of creating a statistically significant hedge return.

The changes in the performance of the other value drivers after omitting the micro-caps are smaller. These were also moderately correlated with market capitalization and therefore their performance slightly decreases as the micro-caps are omitted. The changes are, however, relatively small. The pecking order of the rest of the value drivers remains the same after omitting the micro-caps.