The Sophisticated and the Simple: the Profitability of Contrarian Strategies

Abstract

A variety of variables have been used to form contrarian portfolios, ranging from relatively simple measures, like book-to-market, cash flow-to-price, earnings-toprice and past returns, to more sophisticated measures based on the Ohlson model and residual income model (RIM). This paper investigates whether: (i) contrarian strategies based on RIM perform better or worse than those based on the Ohlson model; (ii) contrarian strategies based on more sophisticated valuation models (e.g. Ohlson and RIM) perform much better than the relatively simpler ranking variables that have been used so extensively in the finance literature. Given that the RIM and Ohlson models require greater information inputs and technical know-how, and make different implicit assumptions on future abnormal earnings,it is important to ascertain if they offer significantly greater contrarian profits to outweigh the increased costs that they entail. Indeed, our surprising finding is that simple cash flow-to-price measures appear to do almost as well as the more sophisticated alternatives. One would have expected the sophisticated models to significantly outperform the simple cash flow to price model for the reasons given by Penman (2007).

More than Just Contrarians: Insider Trading in Glamour and Value Firms

“…This is entirely consistent with the results reported in Gregory et al (), who show that significant alphas accrue to some of the Lakonishok et al . () trading strategies in the UK, and more recently by Dissanaike and Lim () who also show that other UK portfolio formation strategies give rise to abnormal returns that are not priced by the Fama‐French model.…”

“…These definitions CF/P, E/P and D/P have all been suggested as alternatives to B/M for identifying value stocks. Dissanaike and Lim () show that cash flow measures generate stronger risk‐adjusted returns than either book value or earnings based measures, an effect that persists for two years post portfolio formation. We specifically consider the D/P ratio as companies with high dividend yields have been shown to outperform companies with low dividend yields, and this is a classification of value that has not be considered by any US study.…”

External Financing, Growth and Stock Returns

“…(1997), Doukas et al . (2002), Bauer et al (2010), Dissanaike and Lim (2010) and Gregory et al (2011).…”

Long-term return reversals—Value and growth or tax? UK evidence

“…Regarding to the value-growth features, Li et al (2009) analyze the value premium and find that high return volatility is one of possible causes for the superior performance of value stocks in the UK from the 1963 to 2006 period. Recently, Dissanaike and Lim (2010) investigate contrarian strategies by incorporating the accounting information based upon the Ohlson (1995) and the residual income model. They find that the accounting information based contrarian strategies cannot outperform the BM (book-to-market) based contrarian strategies.…”

“…The evidence of long-term stock return reversals has been found across a wide range of developed and developing markets (Antoniou et al, 2005;Bhojraj and Swaminathan, 2006;Chou et al, 2007;Dissanaike and Lim, 2010;Gupta et al, 2010;McInish et al, 2008;Nam et al, 2003;Wongchoti and Pyun, 2005). While the outperformance of loser stocks relative to winner stocks is generally accepted, indentifying causes of return reversals has been more controversial.…”