Sara Wong, National Australian Bank’s quantitative analysis, has developed a portfolio
construction model about which he is excited. To create the model, Sara made a list of the
stocks currently in the ASX SPI 200 Index and obtained annual operating cash flow, price,
and total return data for each issue for the past five years. As of each year-end, this
universe was divided into five equal-weighted portfolios of 40 issues each, with selection
based solely on the price/cash flow rankings of the individual stocks. Each portfolio’s
average annual return was then calculated.
During this five-year period, the linked returns from the portfolios with the lowest
price/cash flow ratio generated an annualized total return of 18.5%, or 3.9% percentage
points better than the 14.6% on the ASX SPI 200 Index. Sara also noted that the lowest
price-cash flow portfolio had a below-market beta of 0.88 over this same time span.
Part 1
1.1
Using alone or in combination with other variables, beta has little information about
average returns. Used alone, size, E/P, leverage, and book-to-market equity have
explanatory power. There is no relation between beta and average return from 1963-1990.
In combinations, size (ME) and book-to-market equity (BE/ME) seem to absorb the
apparent roles of leverage and E/P in average returns (Fama & French, 1993, p4).
Select stocks base on the price/cash flow ratio, and use the beta to measure result. As we
know, the price/cash flow ratio is used by investors to assess the financial viability of
corporations. The beta of lowest price/cash flow is lower than the market’s beta.
According to the research by Fama & French (1993, p55), the beta always used by
measure the investment portfolio risk which can affect the stocks and bonds’ returns. In the
capital asset pricing model (CAPM), the beta means the volatility of the expected excess
asset returns to the expected excess market returns. In addition, the validity of beta is
doubtful due to if an extension to the CAPM, the CAMP direction a lower risk premium
compare to what has actually occurred. Therefore, the efficiency of beta is a questionable.
(Frank and Keith, 2009)
1.2
The single factor is usually the market return. Market model is a typical example of
single-factor model. The change of market share index has the cascades. The form of
single-factor model is simple, less the number of parameters which is easy to estimate and
application is simple. However, the research by Vincent’s which uses the single-factor