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I’m half way through trawling the entire market to find companies meeting the criteria for my modified cyclically adjusted price earnings ratio portfolio.
So far, I have 46 companies “short-listed”, requiring more investigation. It will take a few days for detailed analysis on the one or two companies that might make it through.
In the meantime I thought I’d share with you the findings of a paper which asked whether the value effect is more powerful in companies with a low proportion of their shares traded between institutions, or is more powerful for companies where private investors dominate the share trading.
The value effect in this paper is defined as the extra return by buying companies with high ratios of accounting (book) net assets to market capitalisation compared with investing in companies with low “book equity” relative to MCap.
Of course, this “book to market” ratio effect is well-known in the literature; it has been shown that high B/M shares out-perform low B/M shares in many studies in many countries. Indeed, it is one of the factors used in “smart beta” funds sold by institutions.
(BTW: the literature talks about alpha (extra return above risk-adjusted return). By the time the ideas that we have been discussing in academic land for 20-30 years got through to the marketing people at the fund houses it became beta, not alpha – weird. But it sells! I think it will be oversold, but that is another story).
This paper by Tao Shu does indeed confirm the presence of the B/M effect (“Institutional Investor Participation and Stock Market Anomalies (2013), Journal of Business Finance and Accounting, 40 (5) & (6)).
But Tao Shu notes that the “value premium exists only in stocks with low institutional trading volume and disappears in stocks with high institutional trading volume.”
This is quite a challenge to the idea that the value premium is widespread: it would seem that value investors are best advised to stay away from companies with high levels of institutional investor trades as a percentage of all trading in those shares.
Even if the shares stand on a high book to market ratio subsequent performance will, on average, be no different to the growth (glamour) shares trading on low B/M ratios if institutional trading share is high.
So, how did Tao Shu go about the study?
Method
Data was gathered on US firms traded on the NYSE or AMEX between 1980 and 2005. 177,613 quarterly company data were obtained focused on the proportion of trades which were institutional. Each quarter shares were put into one of three equal-sized categories defined as High, Medium or Low institutional volume
Also for each month Tao Shu obtained each company’s B/M ratio, and then allocated to one of ten B/M ratio level categories. This was done independently of the volume sort.
So for any one month a company could be allocated to any one of 30 Volume-B/M ratio groups.
Shares with few institutional trades
For the lowest tercile (one-third) of companies in terms of institutional volume Tao Shu found that at least two-thirds of the trading volume was accounted for by private investors. Indeed for an average company in this category institutions only traded around 15 – 18% of the shares. Often, the proportion of institutional trades was below 10%.
The following chart shows the monthly returns for each of the ten B/M ratio deciles for only those companies with low institutional volume. These monthly returns are averaged for the three months after portfolio formation, and averaged over all the tests between 1980 and 2005……………………..To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
