Undervalued Stocks Research Articles

Appraisal Ratio and the Mutual Fund's Stock Picking Skill

According to the costly arbitrage theory, stocks with high idiosyncratic volatility deter arbitrageurs from trading against the temporal mispricing to gain profits. Hence, long equity holders, such as equity mutual funds, would not take on too much 'idiosyncratic risk' in their portfolios, unless they have strong beliefs that those assets are undervalued. In this study, we use the holding-based fund-level 'appraisal ratio', based on the Treynor and Black (1973) model, to infer the stock picking skill of actively managed mutual funds in the U.S. equity market. Overall, we find that the degree of a fund portfolio tilting towards stocks with higher 'appraisal ratio' helps to identify those funds with superior stock picking ability, which leads to better future performance. And the effect is stronger following periods with lower investor sentiment, indicating that this approach can identify those skilled fund managers who are active in terms of searching for undervalued stocks. Evidences from quarterly earnings announcements and analyst recommendations complement our conjecture that this measure is a good proxy for the stock picking ability of skilled fund managers in the U.S. active management industry.

Implied Cost of Capital versus Fundamental Valuation Efficiency: A Clarification and Empirical Implications

As the proxy for expected return, the implied cost of capital (ICC) is subject to a mispricing-driven measurement error because the price of a stock used to compute ICC can deviate from its intrinsic value. For undervalued stocks, the mispricing-driven measurement error is positive and increases with the degree of undervaluation while for overvalued stocks, the mispricing-driven measurement error is negative and decreases with the degree of overvaluation. Therefore, ceteris paribus, lower ICC is equivalent to higher (lower) fundamental valuation efficiency (FVE) for undervalued (overvalued) stocks. Furthermore, our evidence, based on 11 constructs, shows that the estimated relation of an FVE-associated construct with ICC is a potentially biased estimate of its relation with expected return because its estimated relation with ICC also captures its relation with the mispricing-driven measurement error, the sign of which switches between undervalued and overvalued stocks. Existing methods do not seem able to address the bias.

Do Firm Size Influence Financial Analyst Research Reports and Subsequent Stock Performance

This study investigates whether analysts issue more favorable research reports for small stocks than for large stocks. Small stocks tend not to attract investors due to their size, bad liquidity, easily manipulated price, insufficient information, and high-uncertainty risk. If analysts follow a small stock, it might be because the firm is thought to have good prospects. This study finds that analysts report more positively on small stocks, including in their stock recommendations and earnings growth forecasts. The empirical results show that small stocks perform better in the following year than do other stocks but that this is not the case for operating performance. This finding suggests that analysts are more likely to recommend under-valued stocks, but this may not imply that the operating performance of these stocks will improve the following year.

The Effect of EPS and Return on BEI IDX using Value Investing from Benjamin Graham

This study intends to analyze the value of existing companies in Indonesia Stock Exchange (BEI) to select stocks which will gain a high level of return in the long term. Using fundamental analysis method of value investing Benjamin Graham, this method is used to select undervalued stocks, stocks that are expected to provide high returns over the long term. This study was conducted on 20 companies selected according to the criteria of value investing Graham of 331 companies that listed on the BEI in the period 2005 to 2012. With those datas, the research analyze the effect of Earning Per Share (EPS) and Return of the Shares on IHSG. Pooled Least Square method with the regression equation will be obtained. The result said that changes in the value of EPS is not a significant effect on changes IHSG in BEI, but changes in the value of stock returns has significant impact on IHSG changing, while the variable IHSG simultaneously influenced by both variables, EPS and stock return variable.

The Effect of EPS and Return on BEI IDX using Value Investing from Benjamin Graham

This study intends to analyze the value of existing companies in Indonesia Stock Exchange (BEI) to select stocks which will gain a high level of return in the long term. Using fundamental analysis method of value investing Benjamin Graham, this method is used to select undervalued stocks, stocks that are expected to provide high returns over the long term. This study was conducted on 20 companies selected according to the criteria of value investing Graham of 331 companies that listed on the BEI in the period 2005 to 2012. With those datas, the research analyze the effect of Earning Per Share (EPS) and Return of the Shares on IHSG. Pooled Least Square method with the regression equation will be obtained. The result said that changes in the value of EPS is not a significant effect on changes IHSG in BEI, but changes in the value of stock returns has significant impact on IHSG changing, while the variable IHSG simultaneously influenced by both variables, EPS and stock return variable.

The Magic Formula: Value, Profitability, and the Cross Section of Global Stock Returns

Buying profitable, undervalued stocks and shorting unprofitable, overvalued stocks yields significant return differentials in North America, Europe, Japan, and Asia. Using data from 1991-2016, we test Greenblatt’s (2006) “Magic Formula” (MF) and find that a modified MF which uses gross profits as a measure of profitability yields significant abnormal returns for all size groups and in all regions. Results from double sorts and Fama-MacBeth regressions show that MF explains the cross-section of returns in addition to size, book-to-market and momentum.

Institutional Investors and Equity Prices: Information, Behavioral Bias, and Arbitrage

This paper investigates how institutional investors matter for asset pricing by using daily institutional trading data and a natural experiment, the split–share structure reform in China. This reform required all listed companies to convert their non-tradable shares to tradable shares after paying a negotiated compensation. We find that: 1). Only passive institutions are privy to company-specific details: they buy (avoid) shares of companies that end up with high (low) compensation ratios on announcement day T0. 2). Trading halts after T0. On the first subsequent trading day T1, both passive domestic institutions and individuals are prone to the disposition effect: they sell a large and abnormal amount of shares in the reform companies with high unrealized gains accumulated during the non-trading period, and 3). The selling pressure drives stock prices significantly below fair values. Both active and foreign institutions take advantage of the stock undervaluation and earn significant abnormal return, which eliminate stock mispricing.

Volatility and the Buyback Anomaly

We find that, inconsistent with the low volatility anomaly, post-buyback announcement long-term abnormal returns are higher when the pre-announcement (idiosyncratic) volatility is high. This is consistent with Stambaugh, Yu, and Yuan (2015) who find a positive relation between returns and residual variance for undervalued stocks, and with Ikenberry and Vermaelen (1996) who argue that a repurchase authorization is an option to buy undervalued stocks. The buyback anomaly also survives when using the five-factor model of Fama and French (2015). Combining volatility with undervaluation indicators proposed by Peyer and Vermaelen (2009) improves the predictability of excess returns after buyback announcements.

Why Do Firms Issue Convertible Bonds? Evidence from the Field

We use in-depth interviews with top corporate executives and a question-conditional analysis of a broader survey sample to examine why companies issue convertible bonds. Our findings suggest that firms use convertibles as an alternative for straight debt, which is deemed too costly or covenant-heavy. Equity tends to be ruled out in a previous step of the security choice process because of perceived stock undervaluation. We obtain considerable evidence for the risk uncertainty theory on convertible issuance, while risk shifting, sequential financing, and backdoor equity theories receive little or no support. Our interviews also highlight the substantial impact of investor demand fluctuations and financial intermediaries on corporate security choices and design.

Optimal execution of accelerated share repurchase contracts with fixed notional

Whether it be to take advantage of stock undervaluation or in order to distribute part of their profits to shareholders, firms may buy back their own shares. One of the ways they do this is by including accelerated share repurchases as part of their repurchase programs. We study the pricing and optimal execution strategy of an accelerated share repurchase contract with a fixed notional. In such a contract the firm pays a fixed notional F to the bank and receives in exchange a number of shares corresponding to the ratio of F to the average stock price over the purchase period (the duration of this period being decided upon by the bank). From a mathematical point of view, the problem is related to both optimal execution and exotic option pricing.

Analisis Reaksi Pasar pada Saat Pengumuman Rights Issue di Bursa Efek Indonesia

T his research tested market reaction when the announcement of rights issue to return and trading volume. There are many different rights issue effects. Based on market timing theory, companies tend to issue stock when their stock price is overvalued. But, investors assess overvalued stocks tend to decline and the undervalued stocks tend to rise. Meanwhile, underwriter in a rights issue showed that, underwritter with good reputation will decreased the level of underpricing and increased trading volume. This research used event study method to measure the significance of the market reactions. Logit regression was also used to test the differences in market response over different valuation and the used of underwriter. T he test results showed an overall hypothesis, the market considers the rights issue announcement as bad news which occurs abnormal negative returns and a decrease in the volume of trade. However market reacts positively to the announcement made by the undervalued company and react negatively to the overvalued company. Meanwhile, the used of underwriter don’t have influance to market reaction although can reduce the level of bad news.

Stock Returns with Four Different Valuation Ratios

In this paper, we investigate whether we can create an excess return or not, by holding ‘adequate investment portfolios.’ No one can have excess returns if the financial market is efficient, as every investor has the same information. However, we often observe the market anomaly phenomena in the real market; a typical example of market anomaly phenomenon is that small firms have higher return in terms of stock price growth. Therefore, using 4 valuation ratios(VRs), PBR, PDR, P/E ratio and PEG ratio, and Fama and French’s(2015, hereinafter FF) five factors, we try to investigate whether we can create excess returns or not. We include these five factors because according to FF(2015), a regression estimator using these 5 factors greatly increases its explanatory power of firm value compared with using FF’s(1993) three factors model. In addition, we also include two more additional variables, firms’ default risk and cash dividends, as controlled variables, alongside FF’s(2015) five factors. This is because after carefully studying previous research and stock price theories, we realize the importance of these two additional controlled variables as stock price determinants. Our 4 VRs are mainly related to the value-investing strategy. Namely, investing an undervalued stock would bring higher stock returns(SRs) in the future, as suggested by many famous fund managers, such as Peter Lynch and Philip Fisher. We also use value weighted(vw) portfolios to investigate the consistence of the directions and strengths of coefficients of model in accordance with different portfolios. The vw portfolios are built by using firm size, 4VRs, and FF’s five factors. If these 4 VRs show a consistent association with SRs in accordance with vw portfolios, we can presume that the relationships between VRs and SR are reliable; and it can be an evidence that investors may have an excess return using the characteristics of VRs. We find that VRs influence SR greatly. In other words, firms with low PBR, PDR and P/E ratios generally have high SRs in the coming year. Among the three VRs, we find that PBR presents the clearest evidence of the existence of market anomaly, followed by PDR and P/E ratios. However, we cannot find any particular relationship between the SR and PEG ratios. We use PEG as we believe that PEG ratio would complement P/E ratios’ week point. However, our results from 3 VRs continuously present that firms with low VRs and high profits generally have high SR. This implies that it is too early to deny the usefulness of PEG. In addition, we likewise find that the PEG ratio has a U-sharp relation to SR. Among the controlled variables, market factor, B/M ratio, investment, and firms’ default risk show strong relationships to the future SR. This suggests that there would be a market anomaly phenomenon in the financial market but the five factors suggested by FF(2015) still are important SR determinants. This paper suggests that there are some relationships between VRs and SR. In other words, there is a high possibility that undervalued stock would raise its price higher than other stocks in the coming years. Our results with VRs and vw portfolios continuously show similar results. This implies that investors who are maintaining the ‘adequate investment portfolios’ would receive a higher income in the coming years. Furthermore, we likewise find that the influence of VRs on SR lasts for many years. implies that investors who are maintaining the ‘right portfolios’ would receive a higher income.

The effects of expectations-based monetary policy on international stock markets: An application of heterogeneous agent model

This study develops an empirical approach to measuring the monetary policy effectiveness for price stability based on stock market expectations. First, we use the fraction of fundamentalists estimated by the model of heterogeneous agents as an indicator of agents' predictions of stock market movements. When the expectations of fundamentalists are the only basis for interest rate policy decision making, our results in seven countries show that those with an overvalued stock price use tight monetary policy so than the price falls to the fundamental level, and countries with an undervalued stock price use expansionary monetary policy so the price increases to the fundamental level. Furthermore, the stock price in the next six months in these countries continues to show a negative reaction to expectations-based monetary policy. In addition, in countries not subject to the influence of monetary policy based on the expectations of fundamentalists, our survey results showed that within the next three months, in more than 33% of cases, stock prices reacted negatively to policy. In short, the effect of expectations-based interest rate policy on price stability is superior to adjustments in the policy rate by monetary policy committees. Our results remain robust following a series of additional tests.

An extension of fuzzy TOPSIS for a group decision making with an application to tehran stock exchange

In financial markets, investors attempt to maximize their profits within a constructed portfolio with the aim of optimizing the tradeoffs between risk and return across the many stocks. This requires proper handling of conflicting factors, which can benefit from the domain of multiple criteria decision making (MCDM). However, the indexes and factors representing the stock performance are often imprecise or vague and this should be represented by linguistic terms characterized by fuzzy numbers. The aim of this research is to first develop three group MCDM methods, then use them for selecting undervalued stocks by dint of financial ratios and subjective judgments of experts. This study proposes three versions of fuzzy TOPSIS (Technique for Order Preference by Similarity to Ideal Solution): conventional TOPSIS (C-TOPSIS), adjusted TOPSIS (A-TOPSIS) and modified TOPSIS (M-TOPSIS) where a new fuzzy distance measure, derived from the confidence level of the experts and fuzzy performance ratings have been included in the proposed methods. The practical aspects of the proposed methods are demonstrated through a case study in the Tehran stock exchange (TSE), which is timely given the need for investors to select undervalued stocks in untapped markets in the anticipation of easing economic sanctions from a change in recent government leadership.

Idiosyncratic risk, costly arbitrage, and the cross-section of stock returns

Abstract We test a new cross-sectional relation between expected stock return and idiosyncratic risk implied by the theory of costly arbitrage. If arbitrageurs find it more difficult to correct the mispricing of stocks with high idiosyncratic risk, there should be a positive (negative) relation between expected return and idiosyncratic risk for undervalued (overvalued) stocks. We combine several well-known anomalies to measure stock mispricing and proxy stock idiosyncratic risk using an exponential GARCH model for stock returns. We confirm that average stock returns monotonically increase (decrease) with idiosyncratic risk for undervalued (overvalued) stocks. Overall, our results support the importance of idiosyncratic risk as an arbitrage cost.

Value Investing with Dividend-to-Market Ratio

The book-to-market ratio (BM) is a noisy metric for value investing because book value is a weak indicator of intrinsic value. Using the dividend discount model of Miller and Modigliani (1961), this paper proposes an alternative metric for value investing: the dividend-to-market ratio (DM), where dividend is measured as profitability minus investment. Test results show that DM effectively distinguishes between undervalued stocks and overvalued ones, leading to substantial economic gains. Further, DM is a parsimonious, more efficient measure to estimate expected returns than a linear model consisting of BM, profitability and investment. An investor can increase a portfolio's Sharpe ratio by adding a DM factor rather than a combination of the BM, profitability and investment factors.

The prediction of stock returns with regression approaches and feature extraction

Value investing is one of the most popular investment strategy for investors to search for the undervalued stocks based on their financial reports and balance sheets. However, the numerous metrics derived from the financial statements are not easy for the investor to analyze and determine the financial health of a company. The main purpose of this study is to employ feature extraction to identify a smaller number of financial ratios for the prediction of stock return which reflects the quality of a company. Two regression approaches, including Multilayer Perceptron model and Meta Regression by discretization model, were incorporated with feature extraction to evaluate the forecast performance for two different industries in Taiwan. The results demonstrated that the prediction errors were improved for both models by the feature extraction strategy which reducing the original 16 variables into 5 variables. Besides that, both models achieved better prediction result in concrete industry rather than rubber industry. Finally, this paper concluded that the overall performance of the Multilayer Perceptron model is better than the other model.

A TEST OF GRAHAM'S AND LYNCH'S STOCK SCREENING CRITERIA ON SHARES TRADED ON THE INDONESIAN STOCK EXCHANGE (IDX)

Benjamin Graham and Peter Lynch listed criteria for screening stocks, which investors could use to identify undervalued stocks that would outperform the market. Numerous tests have been conducted in the United States and other countries, but not yet in Indonesia. Thus, the author aims to test the applicability of Graham’s and Lynch’s formulation on shares traded on the Indonesian Stock Exchange (IDX) by screening stocks that meet the various sets of Graham's and Lynch's criteria and then measuring the performance of the portfolios over the years from 2010 to 2014. The author uses a simple linear regression to measure the performance of the portfolios against the IDX Composite (IHSG). The author discovered that investors who used the combined criteria of Lynch earned positive risk-adjusted returns, of 28.81 percent per year in 2010-2012 and 27.33 percent per year in 2012-2014. While investors who used a combination of two of Graham’s criteria obtained significant risk-adjusted returns of 47.55 percent annually in 2010-2012 and 5.92 percent annually in 2012-2014. However, investors who implemented a combination of three of Graham’s criteria did not earn positive risk-adjusted returns consistently during the research period. The increasingly complex criteria do not improve the performance of the portfolios, because when more criteria are used, less and less stocks can meet the criteria, hence the portfolios become more volatile and investors do not enjoy the benefits from diversification.Keywords: Graham; Lynch; Stocks; the Indonesia Stock Exchange (IDX)JEL Classification: G11, G17

Institutional investors: Arbitrageurs or rational trend chasers

This paper studies the relationship between institutional investor holdings and stock misvaluation in the U.S. between 1980 and 2010. I find that institutional investors overweigh overvalued and underweigh undervalued stocks in their portfolio, taking the market portfolio as a benchmark. Cross-sectionally, institutional investors hold more overvalued stocks than undervalued stocks. The time-series studies also show that institutional ownership of overvalued portfolios increases as the portfolios' degree of overvaluation. As an investment strategy, institutional investors' ride of stock misvaluation is neither driven by the fund flows from individual investors into institutions, nor industry-specific. Consistent with the agency problem explanation, investment companies and independent investment advisors have a higher tendency to ride stock misvaluation than other institutions. There is weak evidence that institutional investors make a profit by riding stock misvaluation. My findings challenge the models that view individual investors as noise traders and disregard the role of institutional investors in stock market misvaluation.

Assessing performance of Morningstar’s star rating system for equity investment

Both institutional and individual investors have a vast array of advisory and ratings services to assist with security selection. One of the most prominent sources of stock ratings is Morningstar. This is the first large-scale study evaluating the performance of portfolios formed using Morningstar’s Star rating system for stocks. We evaluate the performance of portfolios formed using this rating system. Our results provide evidence that the Morningstar stock rating system allows an investor to build a portfolio with superior absolute and risk-adjusted returns over a long period of time. We show that a modest transaction cost will reduce, but not eliminate, these benefits. Overall, our results indicate that Morningstar ratings effectively discriminate between over- and undervalued stocks over the long term.