Risk factor analysis across business segments in the US equity market

Abstract

This report examines whether the excess total return to shareholders could be projected by common accounting and market ratios using regression analysis. Our four most important results indicate that; 1) growth stocks outperformed value stocks from 2002 to 2011, 2) size premium of small stocks was valid before the financial crisis in 2008, 3) companies are penalized by having relatively high cash reserves, and, 4) companies with high degree of leverage do not yield a risk premium in normal financial times, but are instead more influenced by such risks in financial recessions. We also show that differences between industry segments are present, and that some ratios could be more predictive when investigating separate segments. Finally, an investment strategy is constructed based on the result of our analysis. We showed that a positive risk-reward return could be earned by using only public information and the preceding year’s cross-sectional regression estimates.