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  • Stock Valuation and Investment Strategies: Yale School of Management

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    This paper studies the relative investment performance of several stock valuation measures. The first measure is mispricing based on the valuation model developed by Bakshi and Chen (1998) and extended by Dong (1998), referred to as the BCD model. The BCD model relates a stock's fair value to its earnings per share, expected future earnings growth, and long-term interest rates. The paper finds that the BCD model mispricing, momentum, size, price-to-book ratios, and value-to-price ratios are significant predictors of future stock returns, with the BCD model and momentum being the best combined strategy.

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    SSRN-id277008

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    This paper studies the relative investment performance of several stock valuation measures. The first measure is mispricing based on the valuation model developed by Bakshi and Chen (1998) and extended by Dong (1998), referred to as the BCD model. The BCD model relates a stock's fair value to its earnings per share, expected future earnings growth, and long-term interest rates. The paper finds that the BCD model mispricing, momentum, size, price-to-book ratios, and value-to-price ratios are significant predictors of future stock returns, with the BCD model and momentum being the best combined strategy.

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    30 views55 pages

    Stock Valuation and Investment Strategies: Yale School of Management

    Uploaded by

    cheapncheerful
    This paper studies the relative investment performance of several stock valuation measures. The first measure is mispricing based on the valuation model developed by Bakshi and Chen (1998) and extended by Dong (1998), referred to as the BCD model. The BCD model relates a stock's fair value to its earnings per share, expected future earnings growth, and long-term interest rates. The paper finds that the BCD model mispricing, momentum, size, price-to-book ratios, and value-to-price ratios are significant predictors of future stock returns, with the BCD model and momentum being the best combined strategy.

    Copyright:

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    of 55

    Yale ICF Working Paper No.

    00-46

    STOCK VALUATION AND INVESTMENT STRATEGIES


    Zhiwu Chen Yale School of Management Ming Dong York University June 30, 2001

    This Paper Can Be Downloaded From Social Science Research Network at: http://papers.ssrn.com/abstract=277008

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    Table 1 Number of Stocks in the Final Sample


    The stocks in our sample are selected from, and must be in all of, three databases: CRSP, Compustat and I/B/E/S. The original sample from the selection process starts in 1977. As the BCD model estimation requires two years of prior data for each stock, the final sample used for all of our subsequent exercise starts from January 1979, so that the BCD model price for each stock and for every month is determined out of the parameter-estimation sample. Year 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 Mean No. of Stocks 438 566 608 622 671 731 793 880 910 975 1110 1201 1249 1342 1458 1730 1966 2305 1086

    28

    Table 2 Summary Statistics of Firm Characteristics


    This table reports summary statistics for BCD model-determined mispricing (Misp = market/model price - 1), size (=log(ME), where ME is the market value of equity), book/market equity (B/M), earnings/price (E/P), Lee-Myers-Swaminathan Value/Price ratio (V/P), beta, past 6-month return (Ret-6), and past 12-month return (Ret-12), for the sample period January 1979 December 1996. Each stocks beta is estimated using the recent five years (or, a minimum of two years) of monthly-return data. For detailed definitions for ME, B/M and E/P, also see Fama and French (1996). For each characteristic, the value for the 75th and the 25th percentile of all stocks in our sample is respectively reported in the rows marked 75th percentile and 25th percentile. In Panel B, the logarithms of B/M and V/P are used instead of the original ratios.

    Panel A: Statistics for each characteristic/measure


    Descriptive Statistics Mean Max 75th percentile Median 25th percentile Min Misp (%) 3.10 149.95 12.80 1.55 -8.81 -74.60 V/P 0.974 3.100 1.227 0.908 0.654 0.020 B/M 0.728 19.973 0.898 0.592 0.354 0.050 E/P 0.060 1.643 0.095 0.067 0.043 -9.49 ME ($Million) 1793.0 142353.9 1365.3 414.4 140.9 1.1 Beta 1.12 5.05 1.43 1.08 0.75 -2.55 Ret-6 (%) 9.66 561.54 22.08 7.04 -6.86 -81.82 Ret-12 (%) 20.64 1396.15 37.71 14.01 -6.01 -93.85

    Panel B: Pearson correlation matrix


    All entries are statistically significant (p-value < 0.001) except for the one in parentheses. Misp 1.000 -0.204 0.065 -0.164 0.513 0.449 (-0.003) V/P 1.000 0.065 0.210 -0.135 -0.138 -0.357 Size 1.000 -0.220 0.071 0.086 -0.111 B/M Ret-6 Ret-12 Beta

    Misp V/P Size B/M Ret-6 Ret-12 Beta

    1.000 -0.267 -0.362 -0.194

    1.000 0.669 0.024

    1.000 0.048

    1.000

    29

    Table 3 Characteristics of Sorted Quintile Portfolios


    At the beginning of each month, all stocks are sorted into quintiles by one of the following characteristics: BCD model-determined percentage mispricing (Misp), Lee-Myers-Swaminathan Value/Price ratio (V/P), size (ME), book/market equity (B/M), and past 6-month return (Ret-6). This table reports the time-series average characteristics for these quintile portfolios. The labeling of each quintile portfolio is such that MP1, for instance, means the lowest mispricing quintile group (likely, the most undervalued) and MP5 refers to the highest mispricing group (most overvalued). Other labelings imply the same ascending ordering within the respective sorting categories.

    Panel A: Mispricing portfolios (based on Misp)


    MP1 MP2 (Underpriced) Misp (%) -19.63 -4.96 V/P 1.00 1.00 ME ($Millions) 1118.6 1703.9 B/M 0.89 0.81 Ret-6 (%) -7.51 3.03 Ret+1 (%) 2.04 1.83 Ret+6 (%) 9.21 10.20 Beta 1.25 1.05 MP3 2.58 0.96 1975.4 0.75 9.26 1.53 9.44 1.02 MP4 MP5 (Over-priced) 10.59 30.67 0.90 0.78 1966.0 1450.8 0.71 0.69 15.61 27.86 1.31 1.18 8.96 10.12 1.05 1.22 All Stocks 3.86 0.93 1643.3 0.77 9.65 1.67 9.59 1.12

    Panel B: V/P portfolios


    VP1 (Overpriced) V/P 0.41 Misp (%) 9.92 ME ($Millions) 1189.4 B/M 0.58 Ret-6 (%) 15.74 Ret+1 (%) 1.33 Ret+6 (%) 9.10 Beta 1.50 VP2 0.69 5.78 1841.8 0.61 11.31 1.27 8.66 1.31 VP3 0.89 3.11 2187.1 0.70 9.21 1.50 9.16 1.14 VP4 1.11 1.49 1958.2 0.84 7.74 1.59 9.48 0.93 VP5 All (Underpriced) Stocks 1.54 0.93 -0.97 3.86 1343.8 1643.3 1.03 0.77 5.18 9.65 1.87 1.67 10.60 9.59 0.70 1.12

    30

    (Table 3 continued) Panel C: Size (ME) portfolios


    S1 (Small) 63.1 1.35 0.93 0.97 5.97 2.01 11.60 1.25 S2 187.1 3.97 0.92 0.78 10.11 1.66 10.40 1.20 S3 433.6 4.98 0.92 0.72 11.41 1.49 9.08 1.11 S4 1098.7 4.40 0.93 0.73 10.34 1.42 8.71 1.05 S5 (Large) 6438.7 4.57 0.95 0.66 10.43 1.31 8.14 0.97 All Stocks 1643.3 3.86 0.93 0.77 9.65 1.67 9.59 1.12

    ME ($Millions) Misp (%) V/P B/M Ret-6 (%) Ret+1 (%) Ret+6 (%) Beta

    Panel D: B/M portfolios


    BM1 (Growth) 0.25 9.86 0.67 2357.1 19.42 1.52 9.41 1.29 BM2 0.45 4.52 0.83 1924.9 12.48 1.48 9.38 1.21 BM3 0.66 2.89 0.97 1512.5 9.01 1.37 8.91 1.10 BM4 0.89 1.72 1.09 1386.9 6.28 1.56 9.39 0.97 BM5 (Value) 1.61 0.30 1.11 1036.3 1.11 1.95 10.84 1.02 All Stocks 0.77 3.86 0.93 1643.3 9.65 1.67 9.59 1.12

    B/M Misp (%) V/P ME ($Millions) Ret-6 (%) Ret+1 (%) Ret+6 (%) Beta

    Panel E: Momentum portfolios (based on Ret-6)


    MO1 (Low) -18.79 -8.92 0.93 1020.9 0.94 1.51 7.64 1.25 MO2 -1.95 -1.41 0.98 1681.4 0.82 1.56 9.02 1.06 MO3 7.66 3.24 0.97 1975.6 0.77 1.52 9.36 1.02 MO4 18.00 8.10 0.92 2084.1 0.71 1.44 9.70 1.04 MO5 (High) 43.32 18.26 0.82 1452.8 0.60 1.86 12.22 1.21 All Stocks 9.65 3.86 0.93 1643.3 0.77 1.67 9.59 1.12

    Ret-6 (%) Misp (%) V/P ME ($Millions) B/M Ret+1 (%) Ret+6 (%) Beta

    31

    Table 4 Forecasting Regressions of One-Month Returns on Mispricing, V/P and Other Measures
    The dependent variable is the future 1-month holding return (Ret+1). For each given month during January 1979 December 1996, a cross-sectional regression of future returns is run on BCD model mispricing Misp (=market/model price 1), logarithm of Lee-Myers-Swaminathan Value/Price ratio (V/P), Size (=log(ME)), logarithm of book/market equity (B/M), and past 6-month return Ret-6 (or, past 12-month return Ret-12). Once the cross-sectional regressions are done for each month, a time-series average and tstatistic (given in parentheses) are then calculated for each regression coefficient. Each such FamaMacBeth regression is based on non-overlapping future-return observations. Adj-R2 is the time-series average of the adjusted R2 for the cross-sectional regressions. The number of observations reported in the last column is the total number of monthly cross-sectional regressions.

    No. 1 2 3 4 5 6 7 8

    Intercept 2.404 (4.82) 2.357 (4.62) 2.475 (4.92) 2.485 (4.81) 2.500 (4.83) 1.702 (5.79) 1.421 (4.77) 1.629 (5.24) 2.278 (4.78) 2.356 (4.81) 1.629 (5.29)

    Misp -0.029 (-8.97)

    V/P

    Size -0.142 (-2.79) -0.138 (-2.69)

    B/M 0.130 (1.16) 0.162 (1.42) 0.275 (2.53) 0.292 (2.68)

    Ret-6 0.021 (5.91) 0.009 (2.48)

    Ret-12

    Adj-R2 0.051 0.042

    No. Obs. 216 216 216 216 216 216 216 216

    -0.031 (-9.17)

    -0.151 (-2.96) -0.152 (-2.96)

    0.019 (7.99) 0.012 (4.90)

    0.054 0.044 0.027

    -0.017 (-4.61) -0.017 (-4.69) -0.031 (-9.04) -0.017 (-4.61) -0.029 (-7.71) 0.211 (2.21) 0.319 (3.45) 0.291 (2.49)

    -0.143 (-2.87) 0.085 (0.77) 0.017 (7.09)

    0.026 0.031 0.014

    9 10 11

    -0.126 (-2.62) -0.135 (-2.79)

    0.175 (1.72) 0.157 (1.51)

    0.018 (7.77) 0.012 (4.84)

    0.059 0.048 0.010

    215 215 215

    32

    Table 5 Forecasting Regressions of Monthly Returns on Mispricing, V/P and Other Measures by Industry Sector
    For each given month during January 1979 December 1996, a cross-sectional regression of 1-month future return (Ret+1) is run on BCD model mispricing Misp (=market/model price 1), logarithm of LeeMyers-Swaminathan Value/Price ratio (V/P), Size (=log(ME)), logarithm of book/market equity (B/M), and past 12-month return Ret-12. Once the cross-sectional regressions are done for each month, a timeseries average and t-statistic (given in parentheses) are then calculated for each regression coefficient. The Fama-MacBeth regressions are run for each I/B/E/S-defined industry sector, which is reported in the first 2 column. Adj-R2 is the time-series average of the adjusted R for the cross-sectional regressions. The column labeled No. X-obs reports the average number of observations in each cross-sectional regression. We require that the degrees of freedom in each cross-sectional regression be greater than 10. The column labeled No. T-obs reports the total number of separate monthly cross-sectional regressions. Sector Finance Intercept 2.877 (4.70) 1.680 (1.64) 2.302 (3.35) 2.457 (4.27) 2.964 (4.71) 1.119 (1.33) 1.360 (1.33) 3.061 (3.95) 2.644 (4.16) 1.682 (3.08) 1.48 (3.81) 2.135 (4.07) Misp -0.058 (-6.95) -0.041 (-2.76) -0.049 (-5.74) -0.052 (-6.91) -0.043 (-4.68) -0.030 (-2.74) -0.031 (-2.28) -0.017 (-2.43) -0.040 (-6.41) -0.040 (-6.47) -0.047 (-6.31) -0.026 (-4.84) V/P 0.060 (0.33) 0.125 (0.24) 1.027 (3.40) 0.493 (2.55) 0.468 (2.07) -0.027 (-0.08) 0.526 (0.90) 0.210 (0.64) 0.527 (2.82) 0.581 (2.90) 0.649 (2.28) 0.159 (1.29) Size -0.155 (-1.64) -0.040 (-0.32) -0.067 (-0.79) -0.152 (-2.24) -0.264 (-3.42) 0.019 (0.21) -0.059 (-0.45) -0.136 (-1.67) -0.167 (-2.12) -0.021 (-0.34) -0.092 (-1.81) -0.126 (-1.93) B/M -0.071 (-0.43) 0.343 (1.15) 0.410 (2.05) -0.144 (-0.84) 0.031 (0.17) 0.537 (2.68) 0.068 (0.15) 0.444 (1.97) 0.220 (1.53) 0.424 (2.39) 0.665 (3.31) 0.293 (2.23) Ret-12 0.014 (2.80) 0.039 (5.60) 0.023 (5.41) 0.024 (5.92) 0.014 (2.81) 0.006 (0.91) 0.011 (1.30) 0.013 (3.46) 0.014 (3.66) 0.025 (6.30) 0.025 (4.88) 0.018 (6.23) Adj-R2 0.100 No. X-obs 72.9 No. T-obs 212

    Health Care Consumer Non-durable Consumer Services Consumer Durable Energy

    0.138

    41.8

    174

    0.094

    51.0

    213

    0.060

    91.0

    215

    0.072

    46.3

    213

    0.132

    29.7

    211

    Transportation Technology

    0.064

    26.0

    139

    0.050

    88.2

    213

    Basic Material Capital Goods Utilities

    0.088

    71.7

    213

    0.066

    79.3

    213

    0.154

    73.2

    213

    Other

    0.061

    241.7

    213

    33

    Table 6 Forecasting Regressions of Monthly Returns on Mispricing, V/P and Other Measures by Calendar Month
    For each particular month in each year during 1979 1996, a cross-sectional regression of 1-month future return (Ret+1) is run on BCD model mispricing Misp (=market/model price 1), logarithm of Lee-MyersSwaminathan Value/Price ratio (V/P), Size (=log(ME)), logarithm of book/market equity (B/M), and past 12-month return Ret-12. Once the cross-sectional regressions are done, a time-series average and t-statistic (given in parentheses) are then calculated for each regression coefficient. Adj-R2 is the time-series average of the adjusted R2 for the cross-sectional regressions. The number of observations reported in the last column is the total number of yearly cross-sectional regressions. Month January Intercept 7.524 (5.19) 3.619 (1.62) 3.957 (2.93) 2.182 (1.25) 3.835 (2.98) 2.480 (2.06) 1.355 (1.09) 0.834 (0.55) 1.861 (1.40) -0.514 (-0.34) 0.159 (0.06) 0.339 (0.26) Misp -0.063 (-4.69) -0.030 (-1.49) -0.029 (-2.63) -0.024 (-2.28) -0.040 (-3.31) -0.012 (-1.08) -0.030 (-2.30) -0.042 (-3.30) -0.022 (-2.55) -0.006 (-0.44) -0.028 (-1.75) -0.023 (-2.42) V/P -0.801 (-1.54) 0.135 (0.34) 0.109 (0.81) 0.028 (0.14) -0.080 (-0.35) 0.789 (3.47) 0.353 (1.01) 0.286 (1.52) 0.134 (0.40) 0.569 (1.54) 0.356 (0.79) 0.597 (2.00) Size -0.655 (-7.16) -0.137 (-0.73) -0.400 (-3.42) -0.136 (-0.62) -0.317 (-2.01) -0.100 (-0.80) -0.067 (-0.49) 0.157 (0.87) -0.184 (-1.49) 0.124 (0.97) 0.069 (0.27) 0.106 (0.74) B/M 0.650 (2.35) 0.481 (1.07) 0.399 (1.09) 0.321 (0.91) 0.136 (0.40) 0.168 (0.50) 0.174 (0.60) -0.025 (-0.06) 0.061 (0.15) -0.012 (-0.04) -0.127 (-0.36) -0.097 (-0.30) Ret-12 0.009 (1.33) 0.021 (2.34) 0.021 (2.92) 0.023 (3.22) 0.011 (2.04) 0.020 (2.05) 0.023 (3.77) 0.009 (1.22) 0.008 (0.80) 0.029 (4.00) 0.023 (2.33) 0.020 (2.03) Adj-R2 0.082 No. Obs 17

    February

    0.078

    18

    March

    0.048

    18

    April

    0.050

    18

    May

    0.043

    18

    June

    0.054

    18

    July

    0.060

    18

    August

    0.059

    18

    September

    0.061

    18

    October

    0.052

    18

    November

    0.071

    18

    December

    0.048

    18

    34

    Table 7 Monthly Returns on Bi-Dimentionally Sorted Portfolios


    At the beginning of each month, all stocks are sorted by the BCD model-determined Mispricing (Misp) into quintiles. An independent sort by firm size (ME) creates another set of quintile groups. The intersection between the two sets of quintile groups then produces a total of 25 ME-Misp portfolios, the average monthly returns of which are displayed in Panel A. For Panels B and C, the second set of independently sorted quintiles is respectively based on each firms book/market (B/M) ratio and past 12month return (Ret-12). The results in Panel D are for portfolios sorted on the Lee-Myers-Swaminathan V/P ratio and momentum (Ret-12). For each bi-dimensionally sorted portfolio (equally weighted), the average monthly return (in percentage) is reported first, followed by the monthly-return standard deviation [in square brackets], and then by the average number of stocks in a typical month for the portfolio {in curly brackets}. Portfolio names such as MP1, S2, BM4, MO5 and VP5 respectively stand for the first mispricing quintile (the most undervalued), the 2nd size quintile, the 4th B/M quintile, the top momentum quintile, and the highest V/P quintile. The MP1-MP5 column (or row) shows the average monthly-return difference between quintiles MP1 and MP5 in a given category, with its associated t-statistic given below in parentheses. The t-statistics are corrected for return autocorrelations up to 4 lags according to Newey and West (1987). The S1-S5, BM1-BM5 , MO1-MO5 and VP5-VP1 columns (or rows) are defined analogously.

    Panel A: Portfolios sorted on BCD model mispricing (Misp) and size (ME)
    S1 (Small) 2.46% [6.60%] {62.9} 1.90 [5.72] {34.9} 1.79 [5.30] {28.7} 1.88 [5.99] {29.1} 1.57 [6.33] {40.7} 1.99 [5.82] {196.1} 0.89 (3.44) S2 2.07 [6.20] {45.2} 1.82 [5.11] {38.8} 1.56 [4.77] {35.0} 1.52 [5.05] {35.4} 1.35 [5.81] {42.5} 1.68 [5.14] {196.8} 0.72 (2.65) S3 1.79 [6.34] {34.0} 1.93 [4.81] {39.3} 1.53 [4.49] {40.6} 1.35 [4.66] {40.5} 1.02 [5.81] {42.4} 1.51 [4.86] {196.7} 0.76 (2.86) S4 1.91 [6.03] {29.4} 1.92 [4.94] {42.2} 1.52 [4.23] {45.1} 1.04 [4.47] {43.7} 0.99 [5.38] {36.5} 1.45 [4.58] {196.8} 0.89 (3.45) S5 (Large) 1.79 [5.81] {24.8} 1.61 [4.76] {41.6} 1.44 [4.38] {47.5} 1.13 [4.26] {48.2} 1.11 [4.54] {34.3} 1.35 [4.23] {196.4} 0.68 (2.62) All Stocks 2.05 [5.92] {196.1} 1.84 [4.77] {196.8} 1.54 [4.29] {196.7} 1.34 [4.47] {196.8} 1.20 [5.29] {196.4} 1.59 [4.78] {982.8} 0.86 (4.00) S1-S5 0.67 (2.13) 0.29 (1.10) 0.34 (1.37) 0.76 (2.24) 0.47 (1.59) 0.64 (2.46)

    MP1 (Underpriced) MP2

    MP3

    MP4

    MP5 (Overpriced)

    All Stocks

    MP1-MP5

    35

    (Table 7 continued) Panel B: Portfolios sorted on BCD mispricing (Misp) and book/market (B/M)
    BM1 (Low) 1.49% [7.18%] {27.8} 1.55 [6.25] {29.0} 1.14 [5.30] {33.7} 1.56 [5.64] {42.4} 1.60 [6.10] {63.5} 1.54 [5.75] {196.1} -0.09 (-0.35) BM2 1.69 [6.48] {34.8} 1.62 [5.37] {37.9} 1.72 [4.89] {41.6} 1.22 [4.92] {42.0} 1.24 [5.64] {40.6} 1.50 [5.16] {196.8} 0.45 (1.69) BM3 1.77 [5.93] {39.0} 1.73 [4.86] {41.7} 1.46 [4.44] {41.3} 1.14 [4.52] {41.3} 0.85 [5.35] {33.4} 1.39 [4.70] {196.7} 0.92 (3.19) BM4 2.24 [5.83] {39.8} 1.91 [4.68] {44.1} 1.49 [3.99] {44.0} 1.20 [3.91] {40.5} 0.97 [5.19] {28.4} 1.59 [4.29] {196.8} 1.27 (5.02) BM5 (High) 2.60 [6.02] {55.2} 2.15 [4.67] {44.1} 1.80 [4.56] {36.1} 1.59 [4.83] {30.5} 0.97 [5.53] {30.5} 1.95 [4.81] {196.4} 1.63 (5.94) All Stocks 2.05 [5.92] {196.1} 1.84 [4.77] {196.8} 1.54 [4.29] {196.7} 1.34 [4.47] {196.8} 1.20 [5.29] {196.4} 1.59 [4.78] [982.8} 0.86 (4.00) BM5BM1 1.07 (3.89) 0.60 (2.21) 0.65 (2.59) 0.03 (0.11) -0.63 (-2.08)

    MP1 (Underpriced) MP2

    MP3

    MP4

    MP5 (Overpriced)

    All Stocks MP1-MP5

    0.41 (1.72)

    36

    (Table 7 continued) Panel C: Portfolios sorted on BCD mispricing (Misp) and momentum (Ret-12)
    MO1 (Low) 1.73% [6.26%] {102.0} 1.28 [5.40] {38.5} 0.75 [5.55] {20.3} 0.69 [6.83] {15.1} 0.08 [7.12] {21.2} 1.30 [5.76] [196.1} 1.64 (5.81) MO2 2.20 [5.53] {46.5} 1.54 [4.73] {64.7} 1.18 [4.36] {43.8} 0.71 [4.99] {26.5} 0.68 [5.96] {15.4} 1.38 [4.67] [196.8} 1.55 (5.07) MO3 2.60 [6.38] {21.0} 1.78 [4.78] {48.1} 1.44 [4.17] {58.7} 1.11 [4.29] {46.6} 0.48 [5.19] {22.4} 1.44 [4.38] [196.7} 2.12 (7.05) MO4 2.70 [6.56] {14.0} 2.38 [5.28] {28.4} 1.87 [4.51] {47.7} 1.46 [4.27] {63.2} 1.03 [4.79] {43.3} 1.69 [4.49] [196.8} 1.67 (7.23) MO5 (High) 3.18 [8.21] {12.7} 3.09 [7.15] {17.2} 2.39 [6.06] {28.1} 2.09 [5.61] {45.3} 1.82 [5.86] {95.3} 2.18 [5.75] [196.4} 1.36 (4.12) All Stocks 2.05 [5.92] {196.1} 1.84 [4.77] {196.8} 1.54 [4.29] {196.7} 1.34 [4.47] {196.8} 1.20 [5.29] {196.4} 1.59 [4.78] [982.8} 0.86 (4.00) MO5MO1 1.37 (3.56) 1.81 (5.20) 1.64 (5.36) 1.41 (4.04) 1.73 (5.35)

    MP1 (Underpriced) MP2

    MP3

    MP4

    MP5 (Overpriced)

    All Stocks MP1-MP5

    0.88 (3.53)

    37

    (Table 7 continued) Panel D: Portfolios sorted on LMS V/P ratio and momentum (Ret-12)
    MO1 (Low) 0.90% [6.69%] {29.8} 0.96 [6.22] {27.5} 1.21 [5.75] {27.7} 1.31 [5.61] {28.4} 1.83 [5.77] {31.6} 1.30 [5.61] {146.7} 0.81 (2.73) MO2 0.90 [5.98] {21.1} 1.13 [5.43] {26.5} 1.19 [5.02] {30.6} 1.50 [4.56] {33.0} 1.74 [4.62] {34.3} 1.32 [4.65] {147.2} 0.75 (2.51) MO3 0.88 [5.65] {19.8} 1.01 [5.95] {28.4} 1.42 [4.54] {30.6} 1.45 [4.27] {33.4} 1.72 [4.24] {33.5} 1.35 [4.35] {147.2} 0.92 (3.17) MO4 1.44 [5.84] {25.3} 1.37 [5.10] {31.5} 1.81 [4.75] {31.5} 1.64 [4.20] {29.3} 2.06 [4.71] {27.9} 1.64 [4.47] {147.2} 0.57 (1.88) MO5 (High) 2.06 [6.70] {49.0} 1.90 [6.08] {31.6} 1.93 [5.78] {25.2} 2.19 [5.36] {21.6} 2.70 [4.60] {18.3} 2.04 [5.70] {146.8} 0.68 (1.40) All Stocks 1.39 [5.94] {146.7} 1.33 [5.14] {147.2} 1.48 [4.77] {147.2} 1.57 [4.29] {147.2} 1.88 [4.39] {146.8} 1.53 [4.71] {735.2} 0.50 (1.70) MO5MO1 0.97 (3.14) 0.87 (3.00) 0.74 (2.91) 0.90 (2.97) 0.81 (1.50)

    VP1 (Overpriced) VP2

    VP3

    VP4

    VP5 (Underpriced)

    All Stocks VP5-VP1

    0.73 (2.83)

    38

    Table 8 Jensens alpha and Sharpe Ratio for Portfolios Sorted on Valuation Measures and Momentum
    At the beginning of each month, all stocks are sorted by the BCD model-determined Mispricing (Misp) into quintiles. An independent sort by Momentum (Ret-12) creates another set of quintile groups. The intersection between the two sets of quintile groups then produces a total of 25 MOMisp portfolios. All the portfolios are equally weighted. For each portfolio, the average monthly Jensens alpha (in percentage) is reported first, followed by the t-statistic (in parentheses) for the Jensen alpha estimate, and then by the annualized Sharpe ratio <in brackets>. Portfolio names, such as MP1 and MO4, respectively stand for the first Mispricing quintile (the most undervalued) and the fourth momentum quintile. The MP1-MP5 row shows the average difference in Jensens alpha between quintiles MP1 and MP5 in a given momentum category, with its associated tstatistic given below in parentheses. The t-statistics are corrected for return autocorrelations up to 4 lags according to Newey and West (1987). The MO5-MO1 column is defined analogously. In Panel B, the valuation measure is the V/P ratio and the variables are defined analogously.

    Panel A: Portfolios sorted on BCD mispricing (Misp) and momentum (Ret-12)


    MO1 (Low) 0.03% (0.13) <0.71> -0.30 (-1.30) <0.48> -0.76 (-3.08) <0.10> -0.85 (-2.71) <0.05> -1.48 (-4.11) <-0.26> -0.34 (-1.54) <0.46> 1.51 (5.43) MO2 0.68 (3.69) < 1.17> 0.17 (1.18) <0.77> -0.17 (-1.21) <0.51> -0.64 (-3.55) <0.09> -0.76 (-3.04) <0.05> -0.02 (-0.14) <0.64> 1.43 (4.73) MO3 1.10 (4.44) <1.30> 0.46 (3.25) <0.98> 0.15 (1.50) <0.78> -0.15 (-1.18) <0.45> -0.81 (-4.01) <-0.08> 0.14 (1.41) <0.74> 1.93 (6.56) MO4 1.19 (4.81) <1.33> 1.00 (5.91) <1.37> 0.55 (4.38) <1.11> 0.18 (1.46) <0.78> -0.34 (-2.29) <0.34> 0.36 (3.44) <0.95> 1.53 (6.85) MO5 (High) 1.45 (3.97) <1.34> 1.53 (5.83) <1.48> 0.97 (4.59) <1.21> 0.67 (4.04) <1.07> 0.34 (1.68) <0.82> 0.71 (4.18) <1.11> 1.14 (3.58) All Stocks 0.44 (2.24) <0.98> 0.43 (3.16) <1.03> 0.20 (2.00) <0.86> 0.02 (0.23) <0.63> -0.23 (-1.48) <0.43> 0.17 (1.50) <0.81> 0.67 (3.41) MO5MO1 1.42 (3.85) 1.83 (6.02) 1.73 (5.62) 1.52 (4.29) 1.82 (5.45)

    MP1 (Underpriced) MP2

    MP3

    MP4

    MP5 (Overpriced)

    All Stocks MP1-MP5

    1.06 (4.56)

    39

    (Table 8 continued) Panel B: Portfolios sorted on LMS V/P ratio and momentum (Ret-12)
    MO1 (Low) -0.86% (-2.84) <0.17> -0.76 (-3.07) <0.22> -0.23 (-1.02) <0.40> -0.14 (-0.63) <0.49> 0.46 (1.82) <0.85> -0.34 (-1.65) <0.45> 1.33 (4.69) MO2 -0.72 (-3.01) <0.19> -0.42 (-2.32) <0.37> -0.19 (-1.13) <0.45> 0.23 (1.66) <0.77> 0.64 (3.55) <0.98> -0.05 (-0.37) <0.59> 1.36 (5.25) MO3 -0.78 (-3.60) <0.18> -0.44 (-2.80) <0.31> 0.12 (0.91) <0.70> 0.26 (2.02) <0.77> 0.71 (4.16) <1.04> 0.07 (0.69) <0.65> 1.49 (5.31) MO4 -0.17 (-0.89) <0.56> -0.03 (-0.20) <0.59> 0.51 (3.68) <1.01> 0.46 (3.55) <0.97> 1.02 (5.03) <1.24> 0.35 (3.31) <0.91> 1.19 (4.47) MO5 (High) 0.32 (1.34) <0.87> 0.48 (2.28) <0.85> 0.64 (3.37) <0.92> 0.99 (4.94) <1.20> 1.73 (4.16) <1.15> 0.64 (3.77) <1.02> 1.38 (2.74) All Stocks -0.33 (-1.77) <0.50> -0.22 (-1.57) <0.53> 0.12 (1.17) <0.71> 0.32 (3.03) <0.88> 0.78 (4.82) <1.17> 0.13 (1.25) <0.76> 1.11 (4.58) MO5MO1 1.19 (4.07) 1.24 (4.46) 0.87 (3.19) 1.15 (4.03) 1.24 (2.35)

    VP1 (Overpriced) VP2

    VP3

    VP4

    VP5 (Underpriced)

    All Stocks VP5-VP1

    0.99 (4.32)

    40

    Table 9 Average Monthly Returns for 3-Dimentionally Sorted Portfolios


    At the beginning of each month, all stocks are sorted by the BCD model-determined Mispricing (Misp) into three tritile groups of equal size. An independent sort by the past 12-month return (Ret-12) creates a second set of tritile groups. A final independent sort by firm size (ME) creates a third set of tritile groups. The intersection of the three sets of tritile groups then produces a total of 27 Misp-Momentum-ME portfolios. Panel A displays the average monthly returns for the small-cap subgroups. Panel B and Panel C display the average monthly returns for the mediumand large-cap subgroups, respectively. For each 3-dimensionally sorted portfolio (equally weighted), the average monthly return (in percentage) is reported first, followed by the monthlyreturn standard deviation [in square brackets], and then by the average number of stocks in a typical month for the portfolio {in curly brackets}. Portfolio names such as MP1, S2 and MO3 respectively stand for the first Mispricing tritile (the most undervalued), the 2nd (medium) size tritile, the 3rd (top) momentum tritile. The MP1-MP3 column (or row) shows the average monthly-return difference between quintiles MP1 and MP3 in a given category, with its associated t-statistic given below in parentheses. The t-statistics are corrected for return autocorrelations up to 4 lags according to Newey and West (1987). The S1-S3 and MO1-MO3 columns (or rows) are defined analogously.

    Panel A: Small size group


    MO1 (Low ) 1.88% [6.15%] {92.0} 1.27 [5.64] {29.0} 0.44 [6.73] {24.8} 1.47 [5.86] {149.8} 1.45 (6.26) MO2 2.49 [5.78] {27.5} 1.66 [4.72] {32.7} 1.10 [5.14] {24.4} 1.81 [4.93] {84.5} 1.34 (5.39) MO3 (High ) 3.24 [7.41] {16.7} 2.59 [5.99] {24.8} 2.21 [6.19] {55.4} 2.53 [6.07] {96.9} 1.02 (3.66) All Stocks 2.17 [6.00] {136.2} 1.79 [5.01] {86.6} 1.53 [5.69] {104.5} 1.86 [5.52] {327.2} 0.64 (3.45) MO3-MO1 1.35 (5.39) 1.32 (5.32) 1.78 (7.20) 1.06 (5.90)

    MP1 (Underpriced) MP2

    MP3 (Overpriced)

    All Stocks

    MP1-MP3

    41

    (Table 9 continued) Panel B: Medium size group


    MO1 (Low ) 1.57% [5.67%] {59.8} 0.91 [4.92] {26.5} 0.29 [6.21] {14.6} 1.24 [5.31] {100.7} 1.26 (4.49) MO2 2.19 [5.50] {28.7} 1.41 [4.10] {52.2} 0.85 [4.70] {28.9} 1.43 [4.36] {109.7} 1.34 (5.86) MO3 (High ) 2.45 [6.99] {14.2} 2.22 [5.44] {32.9} 1.60 [5.59] {70.3} 1.93 [5.45] {117.5} 0.85 (2.93) All Stocks 1.90 [5.43] {102.7} 1.55 [4.36] {111.5} 1.23 [5.22] {113.7} 1.55 [4.81] {327.9} 0.68 (3.41) MO3-MO1 0.88 (2.52) 1.31 (5.32)

    MP1 (Underpriced) MP2

    MP3 (Overpriced)

    1.26 (4.21) 0.69 (3.11)

    All Stocks MP1-MP3

    Panel C: Large size group


    MO1 (Low ) 1.53% [5.54%] {45.8} 1.21 [4.96] {24.8} 0.52 [5.67] {10.1} 1.32 [5.04] {80.7} 1.01 (3.81) MO2 1.67 [5.31] {30.9} 1.34 [4.28] {69.1} 0.48 [4.52] {33.7} 1.20 [4.31] {133.7} 1.19 (6.22) MO3 (High ) 2.33 [6.37] {11.9} 1.93 [4.97] {35.9} 1.35 [4.74] {65.7} 1.62 [4.75] {113.2} 1.04 (4.14) All Stocks 1.71 [5.28] {88.4} 1.48 [4.26] {129.8} 1.01 [4.46] {109.4} 1.37 [4.34] {327.6} 0.71 (4.01) MO3-MO1 0.87 (2.42) 0.72 (2.65) 0.81 (2.34)

    MP1 (Underpriced) MP2

    MP3 (Overpriced)

    All Stocks MP1-MP3

    0.30 (1.18)

    42

    Figure 1: Size-Rank Distribution for the Study Sample


    12 10 8 Size Rank 6 4 2 0 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 Year
    Note: The size-rank for each stock is determined relative to the universe of NYSE stocks and is as given in the CRSP database. For each year, this figure shows the mean, median and 25th percentile size-ranks of all stocks included in the sample under study.

    Mean Median 25th Percentile

    Figure 2: Reversals of Mispricing Across Quartiles


    Q1

    35 Mispricing (% ) 25 15 5 -5 -15 -25 7901 7911 8009 8107 8205 8303 8401 8411 8509 8607 8705 8803 8901
    Q4 Q4 Q4 Q1 Q4 Q4 Q1

    Q1 (undervalued) Q2 Q3 Q4 (overvalued)

    Q4

    Q1 Q1 Q1

    8911

    9009 9107

    9205

    9303 9401 9411

    Date
    All stocks in the sample as of January 1990 are sorted into four quartiles according to each stocks mispricing level in January 1990. Then, the quartile groups are fixed for the years before and after January 1990. The average mispricing is plotted for each quartile and for every month. The relative mispricing ranking of the four groups is reversed thirteen times during the 18 years.

    9509 9607

    Figure 3: Behavior of Mispricing over Time


    Part A: Mispricing Autocorrelation for the Most Undervalued Quartile
    1 Autocorrelation 0.6 0.2 -0.2 -0.6 13 17 21 25 29 33 37 41 45 49 53
    39

    Number of Months Lagged

    Part B: Distribution of Mispricing Mean-Reversion Time Full Sample


    10 9

    Percent of Stocks

    8 7 6 5 4 3 2 1 0 3 6 9 12 15 18 21 24 27 30 33 36 43

    Mean-Reversion Time in Months

    Part A shows the relationship between mispricing autocorrelation and the number of months lagged, for the first mispricing quartile as defined in Figure 2. Part B displays the distribution of the numberof-months for a stocks mispricing autocorrelation to become zero, based on the full sample.

    57

    Figure 4. Behavior of V/P over Time


    Q1(low)

    Part A: Behavior of V/P Ratio by Quartile

    Q2 Q3 Q4(high

    V/P

    0 7902 8001 8012 8111 8210 8309 8408 8507 8606 8705 8804 8903 9002 9101 9112 9211 9310 9409
    53

    9508
    57

    Date

    Part B:V/P Autocorrelation for the Lowest Quartile


    1 Autocorrelation 0.8 0.6 0.4 0.2 0 -0.2 1 5 9 13 17 21 25 29 33 37 41 45 Number of Months Lagged 49

    Part A shows the average V/P ratio path for each of quartiles that are obtained by sorting all stocks according to their V/P ratios as of January 1990. Part B gives the V/P autocorrelation structure in relation to the number of months lagged, for the first V/P quartile.

    9607

    Figure 5: Behavior of B/M over Time


    Part A: Average B/M by Quartile
    2 Q1 (low) Q2 Q3 Q4(high)

    B/M

    0 7901 7912 8011 8110 8209 8308 8407 8506 8605 8704 8803 8902 9001 9012 9111 9210 9309 9408
    52

    9507
    55

    Date

    Part B:B/M Autocorrelation for the Lowest Quartile


    1

    Autocorrelation

    0.8 0.6 0.4 0.2 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 58

    Number of Months Lagged

    Part A shows the average B/M ratio path for each of quartiles that are obtained by sorting all stocks according to their B/M ratios as of January 1990. Part B gives the B/M autocorrelation structure in relation to the number of months lagged, for the first B/M quartile.

    9606

    Figure 6: Behavior of E/P over Time

    Part A: Average E/P by Quartile


    0.2 0.15 Q1(low) Q2 Q3 Q4(high)

    E/P Ratio

    0.1 0.05 0 -0.05 -0.1 7901 8002 8103 8204 8305 8406 8507 8608 8709 8810 8911 9012 9201 9302

    9403

    9504

    Date

    Part B:E/P Autocorrelation for the Lowest Quartile


    Autocorrelation
    1 0.8 0.6 0.4 0.2 0 -0.2 1 5 9 13 17 21 25 29 33 37 41 45 49 53

    Number of Months Lagged


    Part A shows the average E/P ratio path for each of quartiles that are obtained by sorting all stocks according to their E/P ratios as of January 1990. Part B gives the E/P autocorrelation structure in relation to the number of months lagged, for the first E/P quartile.

    57

    9605

    Figure 7: Relationship between Characteristics and Average Monthly Return


    Part A: Mispricing Level and Future 1-Month Return
    6
    4

    Part B: V/P Ratio and Future 1-Month Return

    Monthly Return (%)

    4 2 0 -2 11.4 15.1 20.2 28.0 -52.6 -25.2 -17.4 -12.6 45.5 1.1 3.4 5.8 -9.0 -6.1 -3.5 -1.2 8.4

    Monthly Return (%)

    3 2 1 0 0.03 0.39 0.52 0.61 0.69 0.76 0.83 0.90 0.97 1.06 1.15 1.26 1.41 1.65 2.32

    Mispricing (%)

    V/P Ratio

    Part C: Size and Future 1-month Return


    6

    Part D: Book/Market and Future 1-month Return


    4

    Monthly Return (%)

    Monthly Return (%)


    12 48 80 118 164 223 299 401 547 769 1075 1572 2523 4673 1876

    3 2 1 0 0.1 0.2 0.3 0.3 0.4 0.4 0.5 0.6 0.6 0.7 0.8 0.9 1.1 1.3

    Size (in $ Million)

    Book/Market

    For each plot, first collect monthly returns and beginning characteristic values for each stock and for every month in the sample. Next, sort the time-series cross-sectional collection into 100 percentile groups. Finally, calculate the average monthly return for each percentile group. Repeat these steps separately for each characteristic.

    2.4

    Figure 7 (continued) Relationship between Characteristics and Average Monthly Return


    Part E: Past Return and Future 1-month Return
    5

    Monthly Return (%)

    4 3 2 1 0 161.5
    0.205

    13.8

    19.4

    25.5

    32.6

    41.5

    53.9
    0.115

    -64.0

    -30.0

    -17.6

    Past 12-Month Return (%)

    Part F: E/P Ratio and Future 1-month Return


    5

    Monthly Return (%)

    4 3 2 1 0 -0.582 -0.010 0.028 0.039 0.047 0.054 0.061 0.068 0.075 0.082 0.090 0.100 0.140

    E/P Ratio

    75.9

    2.9

    -9.3

    -2.8

    8.4

    Figure 8: Investment Performance by Two-Dimensional Portfolios


    Part A Monthly Returns on Mispricing--Size Sorted Portfolios Part B Monthly Returns on Mispricing--Book/Market Sorted Portfolios

    2.5

    3 2.5

    Monthly Return (%)

    2 1.5 1 0.5

    1.5

    0.5

    ed) ervalu (und MP1

    ed) ervalu (und MP1

    MP3
    4 BM 3 BM 2 BM ) low 1( BM

    MP3
    S4 S3 S2 all) (sm S1

    ) alued (overv MP5

    ) alued (overv MP5

    Size

    Ratio B/M

    Part C Monthly Returns on Mispricing--Momentum Sorted Portfolios

    Part D Monthly Returns on LMS V/P Ratio--Momentum Sorted Portfolios

    3.5

    Monthly Return (%)

    3 2.5 2 1.5 1 0.5

    2 1.5 1 0.5

    ed) rvalu (unde MP1

    MP3
    4 MO 3 MO 2 MO ) low 1( MO

    ) (high VP5 VP3


    4 MO

    0
    h) hig 5( MO

    ) alued (overv MP5

    entum Mom

    (low) VP1

    entum Mom

    Monthly Return (%)

    2.5

    Monthly Return (%)

    h) hig 5( BM

    ing ric sp Mi

    ) rge (la S5

    ing ric sp Mi ing ric sp Mi

    h) hig 5( MO

    tio Ra V/P

    3 MO

    2 MO ) low 1( MO

    Figure 9: Risk-Adjusted Alpha of Mispricing-Momentum Portfolios

    2 1.5 1 0.5 0 -0.5 -1


    ) lued erva (und MP1

    -1.5 -2
    MP3
    4 MO 3 MO ) gh (hi O5 M

    d) alue verv (o MP5

    m entu Mom

    Monthly Alpha (%)

    ing ric isp M

    2 MO

    w) (lo O1 M

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