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Portfolio strategies using EVA, earnings ratio or book‐to‐market

Author

Listed:
  • Kenneth Leong
  • Marco Pagani
  • Janis K. Zaima

Abstract

Purpose - Past studies have shown that investment strategy using two popular metrics, the earnings‐price ratio (EP) and book‐to‐market ratio (BM) enable investors to reap abnormal returns. More recent development of another ratio, economic value‐added‐to‐market value (EVAM) can be seen as a hybrid of EP and BM ratios. The purpose of this study is to examine whether portfolios created by utilizing the EVAM ratio will generate higher returns than portfolios formed with EP or BM ratios. Design/methodology/approach - Utilizing the EVA data obtained from Stern Stewart & Co. and financial data from COMPUSTAT and center for research in security prices (CRSP), portfolios are created following the Fama and French portfolio formation methodology. The authors form separate portfolios using EP, BM or EVAM ratios where firms are ranked by a ratio in yeart, then split into deciles. Then portfolios are constructed in yeart + 1 for each decile and equally weighted portfolio returns are calculated. The cumulative ten‐year returns are compared between portfolios formed with EP, BM and EVAM ratios. Findings - There are three interesting findings. One, the EP portfolios depict results that have long been documented. That is, value stock (low price‐to‐earnings ratio firms) and growth stocks (high price‐to‐earnings ratio) exhibit the highest returns. Two, the ten BM portfolio performances are not statistically different. Three, the EVAM ratios indicate that the negative EVAM (lowest decile) portfolio exhibit the highest return and the second highest return is generated by the highest EVAM portfolio. The general results of the thirty portfolios show that the highest EVAM ratio (EVAM10) performs the best. However, the pairwise mean differences between EP, BM and EVAM portfolios do not show statistical differences over the 1995–2004 period. Originality/value - Although investment strategies using EP ratio and BM ratio have been thoroughly studied, investment strategy using EVAM ratio has not. Given that it has been documented that EVA is a better conceptual measure of value, portfolio managers or investors would be interested to know whether utilizing EVA for investment strategy would earn a higher return than strategies that use EP or BM ratios.

Suggested Citation

  • Kenneth Leong & Marco Pagani & Janis K. Zaima, 2009. "Portfolio strategies using EVA, earnings ratio or book‐to‐market," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 8(1), pages 76-86, February.
    • Handle: RePEc:eme:rafpps:v:8:y:2009:i:1:p:76-86
    DOI: 10.1108/14757700910934247
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    Citations

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    Cited by:

    1. Xu, Qifa & Li, Mengting & Jiang, Cuixia, 2021. "Network-augmented time-varying parametric portfolio selection: Evidence from the Chinese stock market," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).
    2. Timo H. Leivo, 2012. "Combining value and momentum indicators in varying stock market conditions," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 11(4), pages 400-447, October.
    3. Farzan Yahya & Zahiruddin B. Ghazali, 2017. "Effectiveness of board governance and dividend policy as alignment mechanisms to firm performance and CEO compensation," Cogent Business & Management, Taylor & Francis Journals, vol. 4(1), pages 1398124-139, January.
    4. Lucian Gabriel MAXIM, 2022. "Model of Financial Analysis for Investments," Economics and Applied Informatics, "Dunarea de Jos" University of Galati, Faculty of Economics and Business Administration, issue 1, pages 87-96.
    5. Eero J. Pätäri & Timo H. Leivo & J.V. Samuli Honkapuro, 2010. "Enhancement of value portfolio performance using data envelopment analysis," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 27(3), pages 223-246, August.
    6. Timo H Leivo & Eero J Pätäri, 2011. "Enhancement of value portfolio performance using momentum and the long-short strategy: The Finnish evidence," Journal of Asset Management, Palgrave Macmillan, vol. 11(6), pages 401-416, February.
    7. Sakchai Naknok, 2022. "Firm Performance Indicators as a Fundamental Analysis of Stocks and a Determinant of a Firm’s Operation," International Journal of Economics & Business Administration (IJEBA), International Journal of Economics & Business Administration (IJEBA), vol. 0(1), pages 190-213.
    8. Mohammad Al-Afeef, 2017. "The Impact of Economic Value Added & Return on Investment on the Changes in Stock Market’s Value (Analytical Study: ASE: 2006-2015)," International Journal of Business and Management, Canadian Center of Science and Education, vol. 12(10), pages 132-132, September.

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