Quantitative Analysis

As a value-oriented portfolio manager, the company defined “value” on the basis of four indicators: the book-to-market ratio, company’s own proprietary modification of I/B/E/S consensus forecast of earnings per share relative to price, operating income per share over price, and level of sales per share over price. The four indicators are used as inputs into a statistical expected-return forecasting model. Keeping the industry the same, companies with low values of these ratios, all else being equal, are expected to have a lower return in the future, which is found to be true when comparing growth stocks to value stocks.

The performance of a firm’s management is evaluated by means of six indicators: return on assets, long-term rate of growth, the amount of share repurchases undertaken, the ratio of the change in sales to assets, earnings-per-share quality, and trades undertaken by company insiders. These six indicators are also inputs into the statistical expected-return forecasting model. The example of trades undertaken by company insiders can serve to illustrate both how a stock-picking engine works and how it can be gradually refined. Transactions of different types undertaken by different people have a different potential to predict ensuing stock-price movements. The research department of the company routinely investigates new leads and directions.

Earnings to price momentum is a time-honored stock-picking engine. In the company’s model, a stock’s attractiveness in the momentum dimension is evaluated according to four indicators: “revision”, which captures the size of the revision, “surprise”, which captures the degree to which the announcement is a surprise, “relative strength”, and “stability”. Both relative strength and stability consider the trend of the past 12 months of daily price. Relative strength rewards an increasing trend and stability rewards low volatility. When a company announces its earnings and the market regards the announcement as a positive surprise, the stock price not only go up immediately but also continues to go up for several weeks thereafter. The same effect in the opposite direction is even more pronounced. A closely related phenomenon is the behavior of stock prices following an announcement that analysts revise their forecasts of future earnings. The combination of these two facts leads to a string of price rises or a string of price drops that represent an investment