What investment strategy would have given you the highest returns in Europe over the 13 year period from July 2000 to July 2014?
In this article I summarised the master’s thesis of Andreas Hennes (completed at Goethe University Frankfurt am Main on 14 September 2015) where he set out to test exactly that.
Results and findings
Before I get to all the details here are the summarised results:
- There is a value premium in the European stock markets. This means value (undervalued companies) outperformed the market and glamour stocks (expensive or highly valued companies)
- Earnings / Price generated the highest return among the single-factor strategies
- Despite a lower geometric mean return of 10.9% Shareholder Yield had the highest Sortino ratio of 0.77
- The annual average value premium compared to the market ranged from 3.8% to 5.9%
- The annual average value stock premium compared to the glamour stock deciles (value companies did better than glamour companies) ranged from 11% to 17%
- The value deciles of all the multi-factor strategies outperformed their respective glamour deciles
- These results confirmed that previous research studies (mainly US studies) that investing in undervalued companies also works in Europe
- Combining value and momentum (the best strategy) to find undervalued companies that are already recovering (share price moving up), is a successful tool you can use to separate winners from losers
- Reducing portfolio diversification to 25 companies can increase your returns.
The following are all the investment strategies he tested:
Single factor investment strategies
- Book-to-Price (B/P) ? this is the inverse of price to book http://www.quant-investing.com/blogs/general/2015/09/18/why-use-book-to-market-and-not-price-to-book
- Sales-to-Price (S/P)
- Operating Cash-flow-to-Price (C/P)
- Earnings-to-Price (E/P) ? inverse of price to earnings
- Dividend-to-Price (Div/P)
- Shareholder Yield (Dividends + net share repurchase / Market value)
- 6-Month Momentum (Current share price / Share price 6 months ago)
- 12-Month Momentum (Current share price / Share price 12 months ago)
- This was how the single factor strategies performed:
The results:
- The two best performing strategies were E/P followed by Shareholder Yield
- Div/P was the strategy with the lowest volatility measured by standard deviation
- E/P and Div/P had the lowest maximum drawdown
- Shareholder Yield had the best risk adjusted returns as measured by the Sharpe and Sortino ratios
Best single ratio strategy – Earnings to Price strategy results
*TANI = Total Accruals to Net Income = (Net Income – Operating Cashflow)/Net Income
Second best single ratio strategy – Shareholder Yield strategy results
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Multi-Factor Investment Strategies
- The F-Score strategy was the Piotroski F- Score combined with Book-to-Price. A good F-Score was defined as greater than 6 and a bad score less than 3. A bad Book to Price ratio was defined as smaller than 0.33 (Price to book ratio greater than 3) and a good book to price ratio as greater than 0.66 (Price to book ratio of smaller than 1.5)
- Multi-Factor Strategy 1 (MFS1) is similar to James O?Shaughnessy’s Value Composite Two which ranks all companies based on Book / Price, Earnings / Price, Sales / Price, EBITDA / EV, Operating Cash Flow / Price and Shareholder Yield.
Instead of EBITDA / EV he used Div/P. ?He did this because he wanted this strategy to consist of all the single factor strategies he tested - Multi-Factor Strategy 2 Top 25 (MFST2 Top 25) = Selected the 25 highest-scoring stocks per decile from the Multi-Factor Strategy 1 strategy but it also included 6-Month Momentum. It is thus a more concentrated strategy (only 25 positions) than the Multi-Factor Strategy 1 and it includes 6-Month momentum.
This was the performance of the multi-factor strategies:
The results:
- The best strategy by far was Multi-Factor Strategy 2 Top 25 with Multi-Factor Strategy 1 (MFS1) in second place
F-Score had the lowest maximum drawdown - Multi-Factor Strategy 2 Top 25 also had the best risk adjusted returns measured by the Sharpe and Sortino ratios
Best multi ratio strategy – Multi-Factor Strategy 2 Top 25
First a reminder, the Multi-Factor Strategy 2 Top 25 (MFST2 Top 25) selected the 25 highest-scoring stocks per decile using the following ratios: Book / Price, Earnings / Price, Sales / Price, Div/P, Operating Cash Flow / Price and Shareholder Yield and 6-Month Momentum.
Here are the detailed results of the strategy:
Second best multi ratio strategy – Multi-Factor Strategy 1
Remember the Multi-Factor Strategy 1 (MFS1) is similar to James O?Shaughnessy’s Value Composite Two which ranks all companies based on Book / Price, Earnings / Price, Sales / Price, EBITDA / EV, Operating Cash Flow / Price and Shareholder Yield.
The difference between James O?Shaughnessy’s Value Composite Two and the MFS1 investment strategy is instead of EBITDA / EV he used Div/P.
It is a pity that this strategy was not also tested with momentum as I liked to see if Andres also found that momentum can add a lot to the returns as we found in our research study (also tested in Europe from June 1999 to June 2011).
Here are the detailed results of the strategy:
Putting all the strategies together
To help you make sense of all the results (single and multiple ratio strategies) I put them all together (only results of Quintile 1) in one table and added colour to the chart.
Red = bad or lowest value
Green = good or highest value
The results:
- Multi-Factor Strategy 2 Top 25 was the best strategy
- 12m Momentum was the worse
- Div/P and F-Score has the lowest standard deviation
- Shareholder Yield had the lowest maximum drawdown and 12m momentum the highest
- Multi-Factor Strategy 2 Top 25 had the best risk adjusted returns and 12m momentum the worse
- Debt/Equity was quite low for all the strategies but there was no link to the best or worse performing strategies
- There was no link between ROIC and the strategies that performed best. This is something we also found in a lot of other research ? quality as measured by ROIC does not help your returns.
How implement the best strategy using the screener
To help you make use of the results of this research here is how you can easily find investment ideas using the best strategy from the paper.
How to implement the best strategy – Multi-Factor Strategy 2 Top 25
As I mentioned the Multi-Factor Strategy 2 consists of combining The Value Composite Two investment strategy with 6-months momentum.
This is what you want to screen for:
- Select all the European stock markets ? or the markets you want to invest in
- Select companies with a daily trading volume of at least $1.5 million (if you are a private investor you can lower this to the liquidity level you feel comfortable with)
- Select the 20% of companies with the best Value Composite Two ranking
- Select the 20% of companies with the best 6-months momentum
- Once you have a list of companies buy the 25 with the best Value Composite Two ranking
- You can either buy a few companies each month or as in the study buy 25 companies and re-balance your portfolio after a year.
This is what the screen looks like:
Source: www.quant-investing.com/screener
As you can see it is very easy to select the ratios and indicators you need which will give you a list of companies that look like this.
This is an example of the companies selected:
Source: www.quant-investing.com/screener
Your list will of course look different because the ranking of the companies change all the time.
You can save this screen and export to Excel
You can save the screen ? and open it with a few mouse clicks ? making it easy for you to get the latest companies selected by the screen.
You can also export the companies selected by the screener to Excel to analyse the results further.
Improve these returns by an average of 200%
Some time ago we tested the Piotroski F-Score with 13 other investment strategies to see if it could increase the returns.
What we found was remarkable.
Combining the F-Score with another investment strategy can give you a lot higher returns ? on average 210% over 13 years.
Here is a summary of by how much the F-Score increased the various investment strategies:
Here you can get all the information on how well the F-Score worked: Can the Piotroski F-Score also improve your investment strategy?
Even though we did not test the Value Composite Two with the F-Score, I am sure you will agree if it increased the return of 13 other investment strategies it is very likely to also increase the returns of the Value Composite Two investment strategy.
All this costs less than a lunch for two
How much can a tool like this to help you select market beating investment ideas cost, you may be thinking?
To make it affordable, and give you a great return on your investment, even if your portfolio is still small we have made the price of the screener very affordable.?It costs less than an inexpensive lunch for two each month (Click here for more information).
Don?t hesitate, you really have nothing to lose – if you are not 100% satisfied with the screener you get all your money back ? guaranteed!
Wishing you profitable investing!
PS Why not sign up now, while this is fresh in your mind?
