The Performance of Common Stocks in Relation to Their B/M and P/E ratios: An Empirical Study of Value Investing in UK Market

Liu, Tianqi (2012) The Performance of Common Stocks in Relation to Their B/M and P/E ratios: An Empirical Study of Value Investing in UK Market. [Dissertation (University of Nottingham only)] (Unpublished)

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Nowadays value investing has been applied all around the world. Numerous studies have been done on evaluating the performance of typical value investing indicators such as cash flow-to-book ratio, sale growth, B/M ratio and P/E ratio and dividend yield. However, seldom studies focus on their performance in UK stock market. This paper employs two basic metrics of value investing strategy, which are firms’ book-to-market ratio and price-to-earnings ratio. The testing period covered a total number of 14 years’ return from April 1998 to April 2012. Both monthly average return and annual mean compound return for value stocks and growth stocks are computed, and compared with the market average return.

Portfolios formed by value stocks are found to significantly outperform value portfolios for each of the buy-and-hold period. When comparing return generated by value stocks and the market average, relatively significant excess return still proved to exist for value stocks held for 1 and 3 years, but no significant superior performance is found for the two categories of value stocks by holding 5 years.

In addition, the regression results based on CAPM suggest that value portfolios of high B/M and low P/E stocks are able to generate above market return after risk adjustment. Nevertheless, the superior return for low P/E value stocks disappears after adding additional risk factors. This result is consistent with Fama and French’s research that small size firms and high B/M ratio firms tend to be riskier. Excess return found for value investing strategy might just be their compensation for taking more risks. Moreover, as high B/M formed portfolio still exhibit a positive alpha with significant t-statistic, B/M is then concluded to be a good metric of value investing strategy, which perform better than P/E ratio.

Item Type: Dissertation (University of Nottingham only)
Depositing User: EP, Services
Date Deposited: 08 Apr 2013 11:20
Last Modified: 25 Oct 2016 07:28

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