Value enhancement using momentum indicators: the European experience
Purpose – The purpose of this research is to study the extent to which various price and earnings momentum measures can be used to enhance portfolio performance by better timing entry into value stocks (and isolating those growth stocks that still have some period to run). Design/methodology/approach – The paper uses the traditional methodology of ranking stocks on the basis of certain value and momentum measures (e.g. book-to-market, market return over some prior period), forming portfolios based on these rankings which are held for a specific period of time. The portfolios are formed on the basis of a single measure of multiple measures and the returns and associated p-values are calculated with the objective of determining how these portfolios perform relative to a benchmark portfolio composed of all the companies in the universe. The analysis is conducted on a database consisting of approximately 8,000 companies drawn from 15 European countries over the period from January 1989 to May 2004. Findings – It was found that a number of individual, and combinations of, price and earnings momentum factors are able to enhance value portfolios by identifying stocks that will not perform well in the immediate future. The best measure that was found for timing entry into value and growth stocks is a combination of price momentum and price acceleration where the difference in monthly performance between the “best” and “worst” value (growth) portfolios is 2.6 percent (2.4 percent) for holding periods of 12 months. It was found not only that this momentum measure can be used to enhance value and growth in portfolios consisting of all European stocks but also that it can be successfully deployed in the major individual markets and regions. Originality/value – Most studies that evaluate the performance of value and growth portfolios do not consider the characteristics of the stocks held in these portfolios. However, it is these characteristics that determine the success of the portfolios formed on the basis of what can only be described as very crude valuation multiples. This paper demonstrates the potential of a closer evaluation of the stocks chosen to be included in a particular portfolio by being able to identify those stocks most likely to perform (and under-perform). The findings in the paper have obvious implications for the investment processes of investment managers but they also provide useful insights into the efficiency of the European markets and the typical means of price formation within those markets.
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