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The best strategies we have tested

The page below shows the most profitable strategies we found in the 50 page research paper called Quantitative Value Investing in Europe: What Works for Achieving Alpha as well as all our research since then.

Easy to implement

Even though the strategies may look complicated at first don’t let that worry you, they are all easy to implement with the screener. And if you struggle remember help is just an email away.

Don’t choose the highest returns, rather find the right strategy for you

These are all strategies with very good returns and your goal here is not to choose the highest return strategy.

Your goal is to choose the strategy that matches your investment style. This will also be the strategy you feel most comfortable with and the one that will allow you to sleep comfortably at night.

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Price Index 6m & Price to Book

The Price Index (PI) ratio (Current share price / Share price 6 or 12 months ago) is another good ratio you can use to find investment ideas.

Strategies involving PI are generally known as momentum strategies as they allow you to profit from the momentum of a company’s share price.

Momentum has been tested in numerous research papers, over long periods of time, and is an investment strategy that outperforms the market.

Before I show you the actual returns first some information on how we tested. 

 

Methodology

We only use historical accounting data and no forecasts.  The reason being is that there is ample evidence that forecasts cannot be relied on.  For example, in his excellent book, ‘The New Contrarian Investment Strategy’, David Dreman mentioned a study that used a sample of 67.375 analysts' quarterly estimates for companies listed on US stock exchanges.

The study found that the average analysts’ error was 40%, and that the estimates were misleading two-third of the time!  A less important but not insignificant factor is that historical accounting data is also cheaper.

 

The backtest universe and benchmark

Our backtest universe is a subset of companies in the Datastream database containing an average of about 1500 companies in the 17 country Eurozone market during our 12-year test period (13 June 1999 to 13 June 2011). 

We excluded banks, insurance companies, investment funds, certain holdings companies, and REITS. 

We included bankrupt companies to avoid any survivor bias. Bankrupt companies, or companies that were taken over, returns were calculated using the last stock market price available before the company was delisted.

We excluded companies with an average 30-day trading volume of less than €10 000.

 

It was not a good time to invest in stocks

The test period was most certainly not a good time to be invested in stocks.
The 12-year period we tested included a stock market bubble (1999), two recessions (2001, 2008-2009) and two bear markets (2001-2003, 2007-2009). 

In spite of all the substantial movements, over the whole period it was essentially a sideways market, as Vitaliy Katsenelson defined in his book, ‘The Little Book of Sideways Markets’. 

 

Holding periods and quintile tests

Each year all the portfolios we tested were formed on 16 June.  We chose 16 June as most European companies have a December year-end and by this date all their previous year-end results would be available in the database. 

The annual returns for our back test portfolios were calculated as the 12-month price change plus dividends received over the period.  Returns were compounded on an annual basis. 

This means each year the return of the portfolio (dividends included) would be reinvested (equally weighted) in the strategy the following year. 

The portfolios were all constructed on an equal-weighted basis.

In order to test the effectiveness of a strategy, we divided our back test universe into five equal groups (quintiles), according to the factor we were testing.  For example, when testing a low price-to-book (PB) value strategy, we ranked our back test universe from the cheapest (lowest PB) to the most expensive (highest PB) stocks. 

The cheapest 20% of companies were put in the first quintile (Q1), the next in the second, and so on, with the 20 % of companies with the highest price-to-book value in the fifth quintile (Q5).

 

Momentum returns and improvements

 But, as you have seen with other one ratio investment strategies, it can be substantially improved.

But before we get to that here are the back tested returns you could have earned if you used a high Price Index strategy to invest in Europe over the 12 year period 13 June 1999 to 13 June 2011.

Price Index 6 months
PI_6m_stand_alone

Source: Quantitative Value Investing in Europe: What works for achieving alpha

Price Index 12 months
PI_12m_stand_alone

 Source: Quantitative Value Investing in Europe: What works for achieving alpha

Q1 (Quintile 1) represents the 20% of companies with the highest Price Index (share price has gone up the most) and Q5 (Quintile 5) companies with the lowest Price Index (share price has gone up the least or fallen the most).

For both strategies the highest PI companies (Q1) substantially outperformed the market, which over the same 12 year period returned 30.54%.

As you can see the strategies worked best for small companies.

You can do even better
As mentioned you can improve your returns substantially if you combine the PI with another ratio or indicator as the table below shows:

Price Index 6 months (highest 6 month Price Index companies combined with)

PI_6m_multifactor

Source: Quantitative Value Investing in Europe: What works for achieving alpha

Best combination – Price to Book (PB)
The best way to increase your returns was to combine 6 month PI with low Price to Book value companies.

Price Index 12 months (highest 12 month Price Index companies combined with)

PI_12m_multifactor

Source: Quantitative Value Investing in Europe: What works for achieving alpha

Best combination – 12 month PI
The best way to increase your returns was to combine 12 month PI again with the top 20% of companies with the best 12 month Price index. This would have given you a list of companies whose share price has gone up the most over the past year.

Your second best strategy would have been to combine 12 month Price index with low Price to Book value companies.

PI 6 month the better strategy
You can however see that the 6 month Price Index would have given you much higher returns.

Exact definition – in glossary
You can find the exact definition of all the ratios and indicators in the Glossary.

 

Be careful! – Long periods of under-performance

Although the Price to Book ratio is a good valuation ratio it also has long periods of under-performance, please refer to the following article: Be careful of this time tested value ratio

 

Use Book to Market rather than Price to Book

When searcing for low Price to Book companies it is better if you use the Book to Market ratio (the inverse of Price to Book) to see why read the following article: Why use book to market and not price to book?

 

 

Period
May 1999 - Jun 2011

Index
+2.25% pa

Return
+23.5% pa +1157.5% 12yr