Alternative valuation techniques for predicting UK stock returns

Abstract

Using daily data over the period 31st December, 2000, to 31st December, 2002, and five variables to categorise a panel of 689 stocks from the FTSE All-Share Index along a value–growth dimension, this paper analyses the investment returns obtained from the best decile portfolios of ‘growth’ stocks and ‘value’ stocks. The results suggest that a ‘value–growth’ factor is significant in the UK stock market, no matter which of the five relative valuation techniques is used. Value stocks outperformed growth stocks, on average, for all five relative valuation techniques used during the period studied, both absolutely and after adjustment for risk. Value stocks also outperformed the market, on average, for all five relative valuation techniques, both absolutely and after adjustment for risk. The lowest market capitalisation decile portfolio was the best performing relative valuation technique, in terms of its risk-adjusted return, and the level of returns for all the value deciles were significant, no matter which of the five methods of selecting the value decile portfolio was used. According to the correlations, there was a fairly high degree of similarities in the daily variation of the different value deciles' stock returns. One can therefore use the term ‘value’ across all the techniques used to select value portfolios, as they are clearly detecting similar investment return characteristics. There is enough of a difference in the variation of returns, however, to make it possible for an analyst of investment funds to detect whether a certain portfolio is composed using a particular valuation technique.