6: FY1 Yield

Description of Factor:

The forward twelve month estimated EPS divided by closing market price. The rationale behind this factor is the expectation that stocks with high expected value will perform better than those will low expected value. This factor is similar to a P/E screen but it includes stocks that have zero or negative earnings which P/E does not.

Analysis

Equal Weighted: This factor has strong predictive powers for returns. The equal weighted portfolios produce a clear step down pattern with an annualized average return of 37.21% for quintile 1 and a 9.36% return for quintile 5. A long-short strategy based on this factor would produce an annualized average return of 27.85%. The standard deviation for quintile 1 is 16.63, with a beta of 1.08 and an R² of .72. The standard deviation for quintile 5 is 17.98, with a beta of 1.10 and an R² of .63.

Except for 1999, the quintile 1 has the highest returns, and most years the quintile 2 has the second highest returns. The quintile 5 does not consistently have the lowest returns, but except for 1999 the returns are lower than quintile one. A long short strategy would work very well using the equal weighted quintile, even earning very positive returns when the benchmark market is negative.

Value Weighted: The value weighted portfolios also follow a nice step distribution of returns from quintile 1 down to quintile 5. The statistical analysis is similar to the equal weighted, with the most significant difference being in a lower standard deviation of quintile 5 in the value weighted. The primary effect of this is a lower variation in the quintile 5, with it having the lowest returns most of the years.

The value weighted portfolios give in a clear step down pattern with an annualized average return of 34.44% for quintile 1 and 8.27% return for quintile 5. A long-short strategy based on this factor would produce an annualized average return of 27.85%. The standard deviation for quintile 1 is 16.55, with a beta of 1.19. The standard deviation for quintile 5 is 14.72, with a beta of .95.

Conclusion:

Based on the analysis above, FY1 Yield is a strong candidate for creating a long-short trading strategy. It is a good indicator of growth and in most years has a good differential in returns between quintile 1 and quintile 5. Since the turnover of the portfolios is moderate, executing a trading strategy on this factor would not result in high transaction costs.