This page includes various studies on investing strategies.
Factor Rotations: When Do Growth and Value Outperform?.
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Dr. G. Kevin Spellman, CFA
December 18, 2022
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Understanding factor rotations is paramount to managing a fund through good and bad times. This article presents the drivers of growth and value outperformance. The cycle of factor performance is impacted by four macro forces including economic growth, interest rates, market returns, and value dispersion.
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Dr. G. Kevin Spellman, CFA
February 4, 2020
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Interest in ESG – Environmental, Social, and Governance – issues is growing, and for good reason. This study finds that being good to the world is consistent with being good to shareholders. Highly-rated ESG firms tend to be more profitable through the economic value added (EVA) lens. Plus, high-ESG stocks that also have high EVA Margin have historically generated above-average returns with below-average risk.
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Dr. G. Kevin Spellman, CFA
October 29, 2019
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Creating business value is about generating profits. More specifically, equity investors gain when profits are greater than they require for the risk borne. Then the firm produces economic profits or adds economic value (EVA is economic value added), which drives up firm value so that market value added (MVA is the firm’s value less the book value of contributed capital) is created.
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This article explores the linkage between economic value and valuation multiples, trends in economic value/profitability, disconnects between profitability and value and investment opportunities this creates, and how the cycle drives alpha for quality (EVA) and value (MVA).
The Time and Place for Active Management.
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Dr. G. Kevin Spellman, CFA
March 7, 2019
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The rise of passive management, index funds and ETFs, has been breathtaking. Is this just a fad, or is it here to last? I suggest it is here to stay, but there are ramifications. Certain market environments, such as those over much of the last decade, favor passive management. However, some of the conditions – low dispersion of stock returns and overall high returns – may be coming to a close.
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This article explores some reasons why active management has performed poorly over the last decade and the possibility for that environment to change. Plus, it provides evidence of what areas of the market provide the most alpha potential and best risk-adjusted returns.
Attractive Cheap, Profitable, Small Companies.
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Dr. G. Kevin Spellman, CFA
November 2, 2018
After rallying earlier this year, small caps have gotten crushed over the last few weeks (figure 1). This is normal during the slowing phase of the economic cycle since small caps have more domestic and cyclical exposure and perhaps less certain financial stability (see Tactical Allocation Over the Cycle). It may also be deserved.
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There has been a growing number of unprofitable small companies (figure 2) that have received, but more than likely should not have, a life line. This is typical during the latter stages of an economic cycle, but it is not necessarily prudent for the long-term. Plus, the median small cap company ($100 million to $5 billion market capitalization) is more expensive than the median large cap company (figure 3) (> $5 billion in market capitalization) despite its widening net margin deficit differential (figure 4). People have been excited to take risk.
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Maybe the correction will shake out the weak small companies from the strong and lead to a more rational market? The median unprofitable small cap stock is down 10.5% from the market peak on 9/20/18, while the median profitable company is down 7.9%.
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The cheap profitable small cap company tends to outperform over time, but investors have preferred the high flyers over the last several years.
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Dr. G. Kevin Spellman, CFA
May 14, 2018
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Technology stocks have been on fire and the FAANGs stocks are constantly in the news. Thus, in this piece of Coach Investing, I thought readers may enjoy a macro review of the technology sector and trends in overall investment spending.
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Given the hoopla over the FAANG stocks, some may believe that a winning investing strategy in technology may be different today than in the past, but after analyzing a myriad of variables from profitability to uses of capital to valuation to market cap, it appears that a successful investing strategy has not changed much since at least the early 1990s. Namely, moderation is best. The moderately valued and profitable companies that do not over- or under-invest tend to outperform. Large companies also perform best.
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This got me thinking… Is the talk of increased regulation in the technology sector reasonable? It could be if large technology firms, as they become bigger, have a disincentive to invest and limit R&D and capital spending to the detriment of consumers.
When Do Value and Growth Outperform?
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Dr. G. Kevin Spellman, CFA
June 5, 2017
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Over the past 30 years, numerous investing “anomalies” have been identified that cannot be explained if the markets are efficient. These factors, which provide the basis of
value and growth investing, range from price multiples to momentum to financial variables that measure corporate performance. As passive investing and ETFs have grown in popularity, new smart beta products that tilt passive portfolios to these factors have taken off. However, while these factors may lead to outperformance over long periods of time, they do not work all of the time and in all areas of the market. There is still a dearth of knowledge of when, and where, these factors work, and this paper provides an answer. Like sectors that have cyclical and defensive qualities and vary in sensitivity to the economy and financial markets, factors have similar characteristics and also rotate predictably through economic and market cycles. For instance, value performs well during early and mid-expansion phases of the economy. At these times, growth is abundant, so there is no need to pay up (higher multiples) for growth; however, when growth is scarce during late economic expansions or early to mid-slowdowns, quality and growth factors outperform. Over about the last 18 months, there were four rotations between value and growth; in general, they were “on schedule” according to the model presented here. [i] Currently, the model points to growth.
Winning with Reasonably Priced Quality Growth
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Dr. G. Kevin Spellman, CFA
March 14, 2017
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A diversified portfolio of reasonably price quality growth stocks outperforms over time. Specifically, a portfolio that avoids high debt and high P/E stocks and focuses on high ROE companies earns above average returns with below average risk.
All else equal, a stock should appreciate as its earnings rise. Growth companies often have unique products or services to offer. However, popular growth stocks are often overpriced, and cannot grow at above average rates forever as products mature and competition intensifies. Thus, while growth is important to returns, one must not overpay for it. As growth slows or becomes negative, P/E declines. Therefore, one can limit the risk of owning growth stocks by avoiding high P/E stocks and investing in low to moderate P/E companies.
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High growth may also arise due to cyclical tailwinds, and people may miss signs of shifting wings. Thus, a better proxy of lasting growth than past earnings growth is high ROE (earnings/equity). Risk can further be reduced by owning quality firms with low to moderate levels of debt. Firms with high levels of debt may not have sufficient cash flows to finance their projects or could have aggressive management teams. Firms with high ROE, which is not leverage with substantial debt, may have some type of competitive advantage (leading to higher margins) and/or operating advantage (leading to higher asset turnover). High ROE companies can use their above-average earnings to plow cash back into the company to generate ongoing growth, pay down debt, pay dividends, buy-back shares, or engage in other shareholder friendly activities.