2. 1-Year EPS Growth

Description of Factor:

The one year estimated EPS growth rate is the consensus analyst estimate of next year’s rate of growth in earnings per share. The rationale behind this variable is the expectation that stocks that have high estimated growth rates will outperform stocks with lower estimated growth rates. From an investment strategy standpoint, this would imply a growth focused strategy rather than a value focused strategy.

Analysis

Equal Weighted: As can be seen from the graph below, the quintiles follow a step distribution with quintile 1 having the highest average annualized return of 23.15% and quintile 5 the lowest average annualized return with 12.83%. The standard deviation for quintile 1 is 18.57% while it numbers 14.84% for quintile 5. The average excess return of quintile 1 is 3.59% while it numbers (4.67)% for quintile 5. The beta for quintile 1 is 1.14 with an R² of 64%, while the beta for quintile 5 is 0.94 with an R² of 68%.

Although the returns are distributed in a favorable manner for a long-short strategy, closer inspection of both the in-sample and out-of sample data reveals inconsistent performance. Out of the sixteen years surveyed, there is only one period of five consecutive years (1990 – 1994) in which quintile 1 yields the highest return of the quintiles. Quintile 5 is more consistent, ranking as the worst performing portfolio eight of the sixteen years sampled. The monthly turnover for quintile 1 is 27.38%, and 31.06% for quintile 5.

Value Weighted: In contrast to that of the equal weighted portfolio, the quintiles of this portfolio do not follow a step-down distribution. In contrast, the returns for both quintiles 2 and 3 are higher than the return of quintile 1 which yields 16.78%. This, in fact, is only slightly higher than the return of quintile 5 with 16.04%. The standard deviation for quintile 1 is 15.89% and 12.68% for quintile 5. The average excess return of quintile 1 is (2.01)% and (2.99)% for quintile 5. The beta for quintile 1 is 1.04, while beta for quintile 5 is 0.83.

As suspected from the discussion of the summary results, the value weighted portfolio would be disastrous if implemented in a long-short strategy. Quintile 1 attains the highest return in only one year, whereas quintile 5 attains the highest return a whopping four years. Quintile 5 also has the lowest return five years over the observed time period.

Conclusion:

Based on the analysis above, it is clear that the equal weighted portfolio produces more consistent results. However, the fact is that the 1 Year EPS Growth factor is not suited as the basis of a successful long-short strategy, at least not as the only factor. Although the equal weighted portfolio indicates the correct ranking of the quintiles in terms of average returns for a long-short strategy, the spread between quintiles 1 and 5 is not large enough to guarantee a comfortable average return over the market. Also, since quintile 1 is only the highest performing portfolio for five of the sixteen years and quintile 5 is not consistently the worst performing portfolio, a long-short strategy based on this factor highly impractical.