Value enhancement using momentum indicators: the European experience

Abstract

In recent years much empirical evidence has been provided on, and many attempts have been made to explain, over-and under-reaction in stock prices which is suggestive that many stocks will oscillate between being over-and under-valued. A number of indicators have been found that prove useful in exploiting these mispricings by identifying cheap stocks to form value portfolios which outperform the market. We establish two characteristics of the individual stocks within these portfolios: (i) the majority of them underperform the market over all reasonable holding periods and (ii) all of the premium associated with value investing is attributable to only a handful of stocks with stellar performance that are included in these portfolios. This highlights the potential of being able to come to a better understanding of the price cycle at the level of the individual stock and so be able better time entry into the stocks that are identified as being cheap by a traditional value indicator but in so doing avoid any erosion in the contribution to the value premium from the small number of stellar stocks typically included. We test a number of momentum/sentiment indicators that can be used to address these issues and so enhance a value strategy using, as our sample, stocks listed on the major European markets over the last 15 years. We find that price momentum combined with its associated acceleration proves to be the best of all the indicators examined, resulting in a doubling of the performance of a pure value strategy and a more than four-fold increase in that of a long/short strategy based on value and growth. Not surprisingly this strategy results in a significant increase in the hit rate of stocks included in this enhanced value portfolio without a significant lose in the stellar stocks that make such an important contribution to the value premium.

Enhancement of value portfolio performance using momentum and the long-short strategy: The Finnish evidence

“…Correspondingly, picking the losers among glamour stocks somewhat increases the proportion of stocks that underperform against the stock market average during the following 1-year period. For the sample employed, the average proportion of outperforming stocks in a value winner portfolio is somewhat higher than reported for pure value portfolios in previous studies (for example Piotroski, 2000;Bird and Whitaker, 2003;Bird and Casavecchia, 2007b), while the proportion of outperformers in value loser portfolios is quite in line with the above-mentioned results for pure value portfolios. However, year-to-year comparisons (in Table 3) reveal the considerable differences between the sub-periods.…”

“…Moreover, larger samples of stocks would enable the testing of the impact of various quantile divisions on the results. In addition, the results of Bird and Casavecchia (2007b) show that at least for value strategies based on individual valuation ratios, the performance improvement can be increased including not only price momentum, but also the acceleration rate of the price momentum. Although beyond the scope of this article, the above-mentioned extensions might provide interesting topics for further research.…”

A Closer Look at Value Premium: Literature Review and Synthesis

“…However, the sales multiples do not indicate whether the sales have been generated without leverage or with maximum leverage, which certainly makes a difference to risks of the firms being compared. In spite of the above‐mentioned disadvantages, evidence has shown that S/P has worked surprisingly well as a relative valuation criterion (e.g., see Bird and Casavecchia, ; Barbee et al ., ; Gharghori et al ., ).…”

“…Bird and Casavecchia () documented the superiority of S/P in the European markets, but found no evidence of added value from combining valuation ratios. Barbee et al .…”

“…To the best of our knowledge, the only exceptions are van der Hart et al . (), Guerard, Jr. (), Bird and Casavecchia (), Leivo et al . (), Leivo and Pätäri (), and Pätäri et al .…”