Value versus Growth: Australian Evidence

Philip Gharghori , Sebastian Stryjkowski and Madhu Veeraraghavan

Department of Accounting and Finance, Monash University, Clayton Campus, Victoria 3800, Australia.

Corresponding Author Philip Gharghori Department of Accounting and Finance Faculty of Business and Economics PO Box 11E Monash University VIC 3800 Australia Tel: 61 3 9905 9247 Fax: 61 3 9905 5475 Email: Philip.Gharghori@buseco.monash.edu.au

Veeraraghavan is a centre associate of the Melbourne Centre of Financial Studies.

Value versus Growth: Australian Evidence

Abstract Fama and French (1992) and Lakonishok, Shleifer and Vishny (1994) show that value stocks earn substantially higher returns than growth stocks. Barbee, Mukherji and Raines (1996) and Leledakis and Davidson (2001) show that the ratio of sales-to-price and debt-to-equity are better predictors of average equity returns than book-to-market equity and firm size. In this paper, we evaluate the ability of size, book-to-market, sales-to-price, cash flow-to-price, earnings-to-price and debt-to-equity in explaining the cross-sectional variation in equity returns. Although our findings show that sales-to-price, earnings-to-price and cash flow-to-price are highly significant in explaining cross-sectional variation in equity returns the book-to-market ratio displays the highest level of significance in joint regressions.

Key words: Fama-French model, book-to-market equity effect, size effect

JEL Classification: G10, G11, G12, G15

1. Introduction
For over three decades, academics and investment professionals have advocated that value strategies outperform growth strategies. Value investing can be traced back to Graham and Dodd (1934) who state that it rests on three key attributes of financial markets1. Graham and Dodd (1934) define value firms as those that have poor past performance and are expected to perform poorly in the future while glamour firms as those that have strong past performance and are expected to perform strongly in the future. They also observe that value firms have high ratios of fundamentals to price (earnings yield, dividend yield, cash flow yield and book to market equity) while glamour firms have low ratios of fundamentals to price. Lakonishok, Shleifer and Vishny (hereafter LSV) (1994) state that value strategies call for investing in companies that have low prices relative to earnings, dividends, book assets or other measures of value. In a similar vein, Kwag and Lee (2006) state that value strategies include investing in companies with high ratios such as book-to-market (B/M), earnings-to-price (E/P), cash flow-to-price (C/P) and high dividend yields. In short, the basic premise of value investing is to invest in stocks trading below their true value. Chan, Hamao and Lakonishok (1991) use earnings yield, cash flow yield, firm size and B/M to determine the cross-sectional predictability of equity returns for Japanese stocks. They report a significant relationship between all four fundamental variables and expected returns in the Japanese market. They also report that of the four variables, B/M and cash flow to yield have the most significant impact on expected returns. Although there is considerable evidence that

First, the prices of financial assets are subject to sudden movements. Second, despite these movements many assets have fundamental economic values that are relatively stable and can be measured with reasonable accuracy by a diligent and disciplined investor. Third, a strategy of buying stocks when their prices are significantly below the intrinsic value will produce superior returns in the long run. Graham and Dodd (1934) referred to this gap as the margin of safety. Based on these attributes, they advanced that a value investor estimates the fundamental value of an asset and compares it to the current market price. If current price is lower than the fundamental value by a sufficient margin of safety, the value investor buys the asset.
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value strategies outperform growth strategies there is little agreement on the interpretation of why value strategies generate superior returns. In an influential paper, Fama and French (hereafter FF) (1992) report that beta has little or no ability in explaining equity returns and document that firm size and B/M explain the crosssectional variation in equity returns better than the beta of a security2. FF (1992) advance that value strategies outperform growth strategies as they are fundamentally riskier investors in value stocks (for example investing in high B/M) are compensated for bearing high fundamental risk. In short, they argue that B/M serves as a proxy for systematic risk. However, Lakonishok, Shleifer and Vishny (1994) not only document that firm size and B/M are not significant in explaining cross-sectional variation in equity returns once cash flow-toprice (C/P) and earnings-to-price (E/P) are included in the model but dismiss the risk-based explanation of FF (1992) by arguing that value strategies generate superior returns due to investor irrationality3. Specifically, they report that value stocks generate superior returns due to expectational errors made by investors. In a similar vein, La Porta (1996) and La Porta, Lakonishok, Shleifer and Vishny (1997) state that value stocks generate superior returns due to behavioural factors and expectational errors made by investors. Chin, Prevost and Gottesman (2002) also conjecture that expectational errors caused by noise trading may play a significant role in the returns of New Zealand equities. They show that longer horizons are required for value strategies to pay off in imperfectly competitive markets than in competitive markets. Barbee, Mukherji and Raines (1996) document that sales-to-price (S/P) may be a more reliable indicator of a firms relative market valuation than B/M because sales figures are less affected by company specific factors than the book value of equity. Barbee et al. (1996) show

Halliwell et al. (1999) and Gaunt (2004) examine the robustness of the FF model for Australian equities. Halliwell et al. (1999) find that there is significant non-beta risk associated with firm size but find little evidence of a B/M effect in explaining equity returns. Gaunt (2004) reports that the FF model explains returns better than the CAPM and that the B/M factor plays an important role in asset pricing. 3 We thank an anonymous referee for suggesting that we acknowledge both rational and behavioural interpretations.
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that size and B/M are not significant in explaining equity returns once S/P and the debt-to-equity ratio (D/E) are included in the regressions. Similarly, Leledakis and Davidson (2001) show that S/P is highly significant in explaining the cross-sectional variation in equity returns in the U.K. These findings add to the growing evidence that alternative measures may be superior to the B/M measure proposed by FF (1992). Hence, it is important to evaluate the ability of variables other than size and B/M in explaining average equity returns. Since, we closely follow Chan et al. (1991), Lakonishok et al. (1994), Barbee et al. (1996) and Leledakis and Davidson (2001) in identifying our set of fundamental variables (we study the behaviour of B/M, S/P, C/P and E/P) as proxies for value/glamour. Thus, we ignore other simple value strategies such as investing in companies with high dividend yields. Our motivation stems from the fact that the bulk of existing research relates to the U.S. market. Little has been published on the performance of value and growth strategies in the Australian market. To our knowledge, there are only two papers that have employed a cross-sectional regression framework to investigate the performance of firm specific variables in explaining average equity returns (Chan and Faff, 2003 and Gharghori, Chan and Faff, 2006). Conducting studies outside the U.S. is important as it addresses the datasnooping hypothesis of Black (1993) and MacKinlay (1995) and the survivorship bias hypothesis of Kothari, Shanken and Sloan (1995). The Australian market provides an interesting setting for this type of study because the value/glamour effect has been empirically shown to be stronger in smaller concentrated markets such as Australia. FF (1998) found that out of thirteen major markets the value/glamour effect was strongest in Australia. The Australian market is unique because it is highly concentrated with around 1,750 listed companies. Although this is comparable to other exchanges, the Australian market is confined to a small number of industries, namely financials and materials (dominated by mining and resources firms). The large number of firms operating in the mining and resources sector introduces a number of challenges when examining firm specific variables based on sales, earnings and cash flows. A large number of firms involved in mining and

resources report earnings and cash flows that are zero or negative in their profit and loss statements during their early years of operation. Given that a large number of firms have negative earnings and cash flows we investigate the relationship between negative E/P, C/P and returns. In addition, we include D/E and size as control variables because of their well documented association with returns (Banz, 1981 and Bhandari, 1988). Consistent with FF (1998) we find evidence of a value premium in Australia when we sort portfolios on B/M, S/P, E/P, and C/P. Our analysis reveals that all of these variables are individually significant in explaining the cross-sectional variation in equity returns in Australia. In the univariate regressions, S/P displays the highest level of significance. However, in the multivariate regressions B/M consistently displays the highest level of significance. It is closely followed by S/P, E/P and C/P. Although S/P, E/P and C/P are significant, only 75% of our sample had recorded sales in their financial statements and only 55% of firms recorded positive values of earnings and cash flows. In comparison, 95% of all firms in the sample had positive book values, making it possible to calculate the B/M ratio for the majority of firms in our sample. This study contributes to the limited Australian literature on the value/glamour effect and asset pricing. We provide evidence that supports the existence of a value/glamour effect in Australia. Furthermore, we identify the firm specific variables which best identify value/glamour firms in Australia. To our knowledge, no published research has examined the value/glamour effect in Australia. Prior studies have only examined B/M as a proxy for value/glamour (see, Chan and Faff, 2003 and Gharghori et al., 2006). The remainder of this paper is organised as follows. Section 2 describes the data and the methods employed in this paper. Section 3 presents the empirical findings and Section 4 concludes the paper.

2. Data and Methods

2.1 Data Our empirical analysis is performed at the monthly level for the period January 1993 to December 2004. The data come from two main sources. The monthly share price data and market capitalisation are sourced from the Australian Graduate School of Management (AGSM) file. Data for total assets, intangibles, total equity, total liabilities4, sales, net profit after tax before abnormals and net cash flows from operations are obtained from Aspect Huntley. Accounting data is collected from January 1992 to December 2004, while price data is collected from January 1993 to December 2004. The full sample is the intersection of the Aspect Huntley and the AGSM databases and is limited to the number of firms for which accounting data is available5. We define book to market as net tangible assets, sales as trading revenue, cash flow as net cash flow from operations, earnings as net profit after tax before abnormals, size as market value of equity and debt as book value of debt. Note that we have omitted market beta from our study. There are at least two reasons for this. First, by excluding beta we remain consistent with Barbee et al. (1996) and Leledakis and Davidson (2001). Second, prior studies (for example, FF, 1992 and Chan and Faff, 2003) find that market beta is insignificant in cross-sectional Fama-MacBeth (hereafter FM) (1973) regressions. Unlike FF (1992), who measure the independent variables on an annual basis, we measure our independent variables on a monthly basis6. As expected returns are not observable, we use subsequent realised returns as a proxy for expected returns in the empirical analysis. Returns are realised monthly returns measured one month after B/M, S/P, C/P, E/P,

In contrast to Barbee et al. (1996) and Leledakis and Davidson (2001), we define debt in D/E as total liabilities. There are two reasons for this. First, to remain consistent with prior research by Gharghori et al. (2006) and second, it is difficult to infer the reliability of book value of common equity using filters. 5 Less than one per cent of the companies in the Aspect Huntley database were not matched to corresponding price data from the AGSM database. 6 The advantage of measuring our independent variables on a monthly basis is that it allows us to draw stronger conclusions on the relationship between our independent variables and returns.
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D/E7 and firm size are measured. To remain consistent with Leledakis and Davidson (2001) and Chan and Faff (2003) the natural log of all fundamental variables is taken. We employ four filters to ensure the accuracy of the accounting data8. Firms that fail to meet these filters are excluded from the final sample. Our filters eliminated 12,818 observations (approximately 9% of the initial sample). This number includes firms with negative book values9 (approximately 5% of the sample) and firms that failed to meet our accounting data filters (a further 4% of the initial sample). Our final sample has a total of 137,139 firm-month observations. A large proportion of our sample firms recorded negative cash flows and negative earnings (45% of firm month observations contain negative cash flows while 43% recorded negative earnings). A sizable proportion of firms (26% of all firmmonth observations) did not record any sales data10. These firms were concentrated in the resources sector.11

In calculating the ratios (B/M, S/P, C/P, E/P and D/E), there is no time lag implemented between the accounting data and price data. This is done following Chan and Faff (2003) and Gharghori, Chan and Faff (2006). 8 First, the accuracy of the balance sheet data used to calculate B/M, size and D/E is checked by enforcing that Assets Liabilities Equity = 0. Second, statement of cash flow data used to calculate C/P is verified by comparing the sum of operating cash flows, investing cash flows and financing cash flows with the net increase in cash held such that NCFO + Total Investing CF + Total Financing CF Net Increase in Cash Held = 0. Third, profit and loss statement data used to calculate E/P is checked by comparing profit before tax and abnormals plus tax expenses to net profit after tax before abnormals such that Profit Before Tax and Abnormals + Tax Expense NPAT Before Abnormals = 0. Lastly, we verify the sales figure by comparing trading revenue plus other revenue with total revenue such that Total revenue Trading revenue Other revenue = 0. 9 We exclude firms with negative book values because they comprise only a small proportion of our sample (5% of all firm month observations). We believe the exclusion of negative B/M does not compromise the external validity of our results. Furthermore, negative B/M has been covered in detail in prior literature, see, Gharghori et al. (2006). 10 We include firm month observations for which no sales data exists in our regressions by assuming a sales figure of zero. We also repeated the analysis omitting the firm-month observations without sales data. Conclusions remain unchanged. Nevertheless, that 26% of the sample has a sales value of zero is a weakness of S/P as a proxy for value/glamour. This is because for this proportion of the sample, there can be no cross-sectional variation between S/P and returns. This is particularly pertinent to investors wishing to use S/P as a value/glamour proxy. 11 66% of the firm month observations for which no sales data exist are classified as gold, other metals and materials according to the GICS classification scheme. Similarly, a large proportion of firms with negative earnings and cash flows also belonged to the resources sector. The mining and resources sector constitutes a high proportion of the Australian market. Many of the listed mining and resources companies do not generate any trading revenue in their early years of operation and thus have negative earnings and cash flows.
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2.2 Methods We relied primarily on two methodologies in our analysis of the relationship between firm specific variables and average equity returns: (1) the portfolio analysis approach, in which portfolios are formed on a chosen variable and the relationship with average returns is investigated, and (2) a cross-sectional regression approach which is based on individual firms rather than portfolios.

2.2.1 Portfolio Analysis The portfolio analysis procedure used is similar to that of Fama and French (1992) and Leledakis and Davidson (2001) in which portfolios are formed every month by placing firms into deciles, based on rankings on each of the six variables chosen for this study. Decile 1 represents firms with the lowest value of the sorting variable while decile 10 has firms with the highest value. Each month, the equally weighted average return of each decile is calculated. This procedure allows identification of any relationships between the sorting variable and the subsequent returns on the portfolios formed. A large proportion of firms in the sample recorded negative values for earnings and cash flows. Negative values of E/P and C/P are considered separately by placing the firms into quintiles instead of deciles. Although the strategy of buying companies with negative earnings has been ignored by prior research, we include this strategy for two reasons. First, Benjamin Grahams stock screens12 classify negative earnings firms as value firms. Second, Jaffe, Keim and Westerfield (1989) argue that negative earnings firms must be included as the strategy is of value to portfolio managers. Further, Jaffe, Keim and Westerfield (1989) and Chan, Hamao and Lakonishok (1991) include securities with negative earnings and document that stocks with negative fundamental values generate high returns. However, it is too simplistic to classify all negative earnings firms as value firms. For example, negative earnings firms might be at an

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Benjamin Graham (1973) uses ten screens to find undervalued stocks. One of the screens he uses is that a firm have no more than two years of negative earnings over the previous ten years.
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earlier stage in their life cycle and may be at the start of a rapid growth phase13. It is difficult though to identify where these early life cycle negative earnings firms would exist on a continuum of all negative E/P firms. In contrast, the concept of value/glamour, which is usually applied to positive B/M, E/P and C/P firms, can similarly be applied to negative E/P and C/P firms. In this context, the most negative E/P firms are the most valuable firms as they are either the most undervalued firms or the most risky14. Conversely, the least negative E/P firms are the least valuable firms15. Given the above, we expect the average returns for the most negative E/P firms (Q1) to be higher than the average returns for the least negative E/P firms (Q5). We interpret negative values of C/P in the same manner.

2.2.2 Fama Macbeth Regressions A cross-sectional framework is employed to identify which variables are significant in univariate and multivariate regressions at the individual firm level. In the cross-sectional regression analysis, the general framework of Fama and Macbeth (1973) is used to remain consistent with Fama and French (1992) and Leledakis and Davidson (2001). This approach involves crosssectional regressions of next months stock returns on the firm specific variables for each month of the sample period. Following, Chan and Faff (2003), our cross-sectional regressions are estimated using OLS adjusted for Whites (1980) heteroskedasticity consistent covariance matrix and WLS is
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We thank an anonymous referee for suggesting this interpretation. Damodaran (2002) states that firms have negative earnings as a result of (a) temporary problems (problems affecting the firm alone, an entire industry and sometimes as a result of downturn in the economy), (b) long-term problems (poor strategic decisions made by the firm in the past, operational inefficiencies or using too much debt to fund its operations) and (c) where the firm is in an early stage of its life cycle (for instance, firms that require huge investments up front, biotechnology firms that have to spend millions of dollars on research and young start-up companies with good ideas but who lose money until they convert these ideas into profitable products). 14 We thank an anonymous referee for suggesting that it may be possible that the price of the most negative E/P firms is correctly bid down to a very low value, reflecting an expectation of continued negative earnings and high risk. 15 It would be inappropriate to term the least negative E/P firms as glamour firms as few firms that report negative earnings would be considered glamorous. However, for the subset of negative E/P firms, the least negative E/P firms are effectively the glamour firms.
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employed to infer the sign and significance of the time series of cross-sectional regression parameters. The focus of the regression analysis is to investigate the individual and joint explanatory power of the six variables in explaining equity returns. The significance of the slope coefficients allows us to measure the ability of the variables to explain equity returns. Different variations of the regression model specified below are estimated and the significance of the coefficients are measured using the aforementioned procedure:

B S C E D R i = 0 + 1ln + 2ln(SIZE) + 3ln + 4ln + 5ln + 6ln + i M P P P E

(5)

The large number of firm month observations with negative earnings and cash flows necessitates an analysis of the explanatory power of both negative and positive values of E/P and C/P. To do so, we split E/P into two separate variables (or two interaction terms for the E/P variable) when conducting the FM regressions. One of the interaction terms for the E/P variable includes the positive values of E/P and zeros in place of the negative E/P observations. The other includes the negative values of E/P and zeros instead of the positive E/P values. The advantage of employing interaction terms for positive and negative E/P values is that allows for asymmetry in the relationship between E/P and returns. The same approach is employed for positive and negative values of C/P. Consistent with Fama and French (1992) we take the log of all fundamental variables. For negative values of E/P and C/P we take the log of the absolute value. Therefore, we expect positive regression coefficients on both positive and negative values of E/P and C/P.

3. Empirical Results
3.1 Preliminaries The results of the portfolio analysis are presented in Table 1. Table 1 shows average monthly returns for the period January 1993 to December 2004 for portfolios formed on book-to-market (B/M), sales-to-price (S/P), debt-to-equity (D/E), firm size, positive earnings-to-price (E/P+),

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negative earnings-to-price (E/P-), positive cash flow-to-price (C/P+) and negative cash flow-toprice (C/P-). [Insert Table 1 about here] Panel A of Table 1 presents the results of sorting on B/M. Panel A shows a strong positive relation between B/M and returns. We find that average returns increase almost monotonically from 0.96% per month for the lowest decile (D1) to 3.75% for the highest (D10), a difference of 2.79% (D10-D1) per month. Panel B presents the results of sorting on S/P. We document a positive relationship between S/P and average returns. We find that the lowest decile (D1) generates a return of 0.51% while the highest decile (D10) generates a return of 2.74%, a difference of 2.23% (D10D1) per month. This finding is consistent with Leledakis and Davidson (2001) and Barbee et al. (1996). However, the spread is smaller than the difference between the smallest and largest B/M portfolios and similar to B/M, the relationship between average returns and S/P is not linear. Panel C shows that average returns are generally increasing with leverage, ranging from 1.26% per month for the smallest D/E portfolio (D1) to 2.62% per month for the largest D/E portfolio (D10) a difference of 1.36% (D10 D1) per month. However, the relationship between leverage and average returns is not linear and the magnitude of the return differential is not as dramatic as that of the portfolios formed on the variables that identify value/glamour firms. Panel D shows that the relationship between average returns and size is negative, consistent with Banz (1981). Once again we observe that the relationship is non-linear. The two lowest deciles contain abnormally high average monthly returns. The portfolio of firms in the lowest decile earns a return of 6.78% per month while the second lowest decile earns 2.24% per month. When we exclude the two smallest deciles and focus on deciles three to ten, we find little variation in average returns. These results suggest that the well documented size effect appears to be driven by the smallest firms. This finding is consistent with Chan and Faff (2003) and

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Gharghori et al. (2006). D/E and size are included in our empirical analysis as they are both well documented anomalies which need to be controlled for in cross-sectional regressions. Panel E reports the average returns for portfolios formed on positive and negative E/P. We find a positive relationship between average returns and E/P+ as average returns increase from 0.89% per month for the lowest quintile (Q1) to 2.67% per month for the highest quintile (Q5), a difference of 1.78% (Q5 Q1) per month. This is consistent with Chan, Hamao and Lakonishok (1991) and LSV (1994). Since Q5 generates the highest returns we identify high E/P stocks as value stocks. As far as negative E/P firms are concerned we find a negative relationship between average returns and E/P-. The most negative quintile (Q1) generates a return of 3.57% per month while the least negative quintile (Q5) generates a return of 0.46% per month. Further, the returns on the quintiles decrease monotonically as E/P becomes less negative (Q1 to Q5). This finding is consistent with our conjecture that the concept of value/glamour can be applied to the subset of firms with negative earnings. Panel F shows a positive relationship between positive C/P and average returns, consistent with Chan et al. (1991). Average returns increase from 0.99% per month for the lowest quintile (Q1) to 2.71% per month for the highest quintile (Q5), a difference of 1.72% per month. As Q5 generates the highest returns we identify high C/P stocks as value stocks. Panel F also shows that the relation between average returns and negative C/P is negative. The difference between the most negative quintile (Q1) and least negative quintile (Q5) is 2.37% per month. In summary, the analysis provides evidence that value strategies outperform growth strategies. A leverage effect is also apparent and the well documented size effect appears to be present, however, only the smallest firms produce large average returns. The one dimensional portfolio sorting method employed for the portfolio returns analysis does not allow us to view the relationships between the fundamental variables. To further investigate the relationship between all six variables, we produce a correlation matrix for the variables. Table 2 presents the time

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series average of the monthly correlations between all six variables. The variables used to construct this matrix are the transformed variables, that is, the natural log of all variables has been taken. [Insert Table 2 about here] The results in Table 2 reveal that the various firm specific variables are correlated to some extent. For instance, C/P and E/P are highly correlated for positive values (52%) and for negative values (56%). A multivariate regression analysis is required to disentangle the impact of the various company specific variables on stock returns.

3.2 Cross-Sectional Regression Analysis 3.2.1 Univariate Fama-Macbeth Regressions The results of the univariate FM regressions are presented in Table 3. All variables, with the exception of firm size and the positive E/P and C/P interaction terms are significant at the 5% level. [Insert Table 3 about here] Panel A of Table 3 confirms the importance of B/M in explaining the cross-section of average returns. B/M has a significant positive coefficient of 0.006, with a t-statistic of 5.65. This result is consistent with Fama and French (1992), Chan and Faff (2003) and Gharghori et al. (2006). The second regression in Panel A of Table 3 is of average returns on S/P. We find that S/P is a powerful predictor of average returns, exhibiting a positive slope coefficient of 0.0029 and the highest level of univariate significance of all the variables in this study (t-statistic of 7.18). This provides strong support for the findings of Barbee et al. (1996) and Leledakis and Davidson (2001). The next two models presented in Panel A of Table 3 employ interaction terms to differentiate positive and negative values of E/P and C/P. The values of positive and negative E/P were regressed simultaneously on next months returns. The results from Table 3 provide

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interesting insights into the relation between E/P and average returns. An unexpected finding is the negative and insignificant coefficient on positive E/P. The average slope from the monthly regressions of returns on positive E/P is -0.0003 with a t-statistic of -0.25. This is inconsistent with the portfolio analysis conducted earlier in which a positive association with average returns and positive E/P was observed. In contrast, we find that the coefficient on negative E/P is positive and significant, consistent with our predictions (t-statistic of 6.46).16 To investigate this further we conducted univariate FM regressions using only the positive values of E/P and returns. We also conducted separate regressions using negative values of E/P and returns. Panels B and C of Table 3 present the results of these regressions. We observe that positive E/P is highly significant with a t-statistic of 6.16. In contrast with the insignificant coefficient on positive E/P reported in Panel A, the result in Panel B is consistent with our portfolio analysis, where we find positive E/P to be positively associated with average returns. The coefficient on negative E/P is also significant with a t-statistic of 2.51. The findings in Panels B and C suggest that the relationship between E/P and returns is stronger for positive E/P values. However, the findings must be interpreted with caution as the regressions were only conducted on individual subsets of positive and negative values of earnings. Our analysis is focused on the full spectrum of earnings and cash flows and for this reason we conduct the first set of multiple regressions using interaction terms to separate positive and negative values of earnings and cash flows. The regression of average returns on C/P is conducted in a manner consistent with those of average returns on E/P. Our findings show that the coefficient is insignificant for positive C/P but positive and significant for negative C/P. The fifth regression in Panel A of Table 3 shows that D/E has a significant influence on average equity returns, as the average coefficient is statistically significant (t-statistic 4.57). This result is consistent with the leverage effect documented by Bhandari (1988) and supports the

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Recall that the log of the absolute value of negative E/P is used in the regression analysis. Thus, a positive coefficient indicates that there is a negative relationship between negative E/P and returns.
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findings of Barbee et al. (1996). The final regression in Panel A of Table 3 shows that size has little influence on average returns. This appears to be inconsistent with the size effect documented by Banz (1981) and Fama and French (1992). The average coefficient is insignificantly different from zero at conventional levels. It is not surprising to find that size is insignificant as the results in Table 1 show that the relationship between size and returns is nonlinear.

3.2.2 Multivariate Fama-Macbeth Regressions Table 4 contains the results of multivariate FM regressions. The aim of these regressions is to identify which of the firm specific variables are the best determinants of average equity returns after controlling for leverage, size and the variables that identify value/glamour firms. [Insert Table 4 about here] Model A of Table 4 shows that when B/M and S/P are regressed simultaneously both variables are positive and significant. This result is consistent with the univariate analysis conducted earlier. The average slopes are 0.0054 for B/M and 0.0023 for S/P. We observe that S/P displays a higher level of significance than B/M with a t-statistic of 6.81 compared to 5.30 for B/M, a result consistent with Barbee et al. (1996) and Leledakis and Davidson (2001). Moreover, a significant positive coefficient is observed for B/M even when other explanatory variables are incorporated into the model (models B, C, G, K, M and N). Similarly, S/P also remains highly significant when other variables are incorporated into the regression specification (models D, E, H, K, M and N). Models B and D of Table 4 provide an interesting result. In the combined regression of B/M and D/E (model B) the average slope of B/M has decreased to 0.0046 and there is a marginal decline in the t-statistic. The regression of S/P and D/E (model D) suggests that S/P is capturing a sizeable leverage effect. The average slope of S/P has decreased from 0.0029 to 0.0019 and the t-statistic has declined from 7.81 to 4.33. The coefficient on leverage remains

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positive and significant with a t-statistic of 3.70. Regression models G and H also support this finding. Regressions of S/P controlled for leverage suggest that part of the explanatory power of S/P is associated with leverage. After controlling for D/E and size we find that B/M is, in fact, a better predictor of average returns. This result is in contrast with the findings of Barbee et al. (1996) and Leledakis and Davidson (2001). Model F of Table 4 presents the regression of next months returns on E/P and C/P. The model specification contains four variables because we allow for both positive and negative values of E/P and C/P. From Table 4 we observe that both variables retain their characteristics from the univariate regressions. Positive E/P displays a negative and insignificant coefficient (tstatistic of -0.46) while negative E/P is positive and significant (t-statistic of 5.47). Similarly, positive C/P is insignificant (t-statistic of 1.71) while negative C/P is positive and highly significant with a t-statistic of 5.02. Regression models I and J in Table 4 are of E/P and C/P, respectively, controlled for leverage and size. Results of these two regressions are analogous to the bivariate regression (model F) in that the negative values of E/P and C/P subsume the roles of the positive variables. The regression of E/P simultaneously controlled for D/E and size shows that positive E/P is not significant while negative E/P is highly significant with a t-statistic of 6.79. Similarly, we find that positive C/P is not significant while negative C/P is highly significant with a t-statistic of 7.76. In both regression specifications leverage remains significant and size is insignificant. Regression model K reported in Table 4 provides a comparison of S/P and B/M by including these two variables together with D/E and size. Recall that in the bivariate regression of S/P and B/M, S/P displayed a higher level of significance. In the regression including S/P, B/M, D/E and size we find that B/M displays the highest level of significance (t-statistic 6.61) while S/P is still significant, (t-statistic 4.63) its explanatory power is reduced. This particular regression specification was used by both Barbee et al. (1996) and Leledakis and Davidson (2001) in their empirical analyses. Barbee et al. (1996) reported that S/P was significant and

16

subsumed the roles of the other variables which were all insignificantly different from zero. Leledakis and Davidson (2001) found that S/P, B/M and size were significant while D/E was insignificant for their entire sample period 1980-1996. The results presented in Table 4 are inconsistent with both of these studies as we find that B/M displays the highest level of significance and both S/P and D/E remain significant while size is insignificant. There are a number of potential reasons why our results differ from Barbee et al. (1996) and Leledakis and Davidson (2001). First, this study is an out of sample test in terms of both the market analysed and the time period analysed. Second, we employ WLS to infer the sign and significance of the times series of regression parameters which Chan and Faff (2003) show is superior to the simple average that most studies, including Barbee et al. (1996) and Leledakis and Davidson (2001), employ. We now focus our attention on regression specifications that contain the expanded set of variables that identify value/glamour firms. Model L in Table 4 provides a comparison of C/P and E/P after controlling for both D/E and size. From Table 4 it can be observed that positive C/P and positive E/P are both insignificant at conventional levels while negative C/P and negative E/P are both highly significant. D/E also remains significant. Model M presented in Table 4 provides insights into which variable is the best proxy for the value/glamour effect. In this model we include all value/glamour proxies while omitting leverage and size. In past regression specifications, we found that the significance of S/P had decreased in the presence of the leverage measure, D/E. The result that emerges from Table 4 is that B/M is the superior proxy for value/glamour, displaying the highest level of significance (tstatistic of 5.77) out of all the variables that identify value/glamour firms. S/P still remains significant with a t-statistic of 4.94. Positive E/P and C/P are both insignificantly different from zero. Negative E/P and C/P are significant, however, the level of significance has decreased for both variables.

17

The final regression we report from Table 4 (model N) is the following months returns on all six variables chosen for this study. The results from Table 4 show that B/M consistently displays the highest level of significance after controlling for both size and D/E. Furthermore, B/M displays the highest level of significance in the joint regression of all four value/glamour proxies. This result is consistent with the findings of Fama and French (1992) and addresses the contentions of Black (1993) and MacKinlay (1995) who claim that B/Ms explanatory power is sample specific.

3.2.3 Multivariate Regressions for Positive and Negative Earnings Sub-samples The univariate regressions on E/P and C/P in Panel A of Table 3 showed that the coefficients on E/P+ and C/P+ were insignificant which was inconsistent with the portfolio return analysis in Table 1 which showed a positive relationship between E/P+ and C/P+ with returns. To further investigate this anomalous finding and to verify the robustness of the multivariate regression results reported in Table 4, we reran the multivariate regressions for both the positive and negative earnings samples separately. Table 5 presents the results of the multivariate regressions on the positive earnings sub-sample while Table 6 reports the negative earnings sub-sample output. Table 5 shows that similar to the sub-sample analysis reported in Table 3 Panel B, the coefficient on E/P+ is significant and positive in all four regression specifications in which it appears. Interestingly, although the coefficients on B/M and S/P are always positive, their significance has decreased markedly. Further, in the models with all value/glamour proxies (model M) and all variables (model N), E/P+ is the only significant variable. In Table 6, the coefficient on E/P- is not consistent across the models. In one case it is significantly positive, in another it is insignificant and in three cases it is negative and significant. B/M and S/P on the other hand remain significantly positive in all models, which is in line with the findings reported in Tables 3 and 4. Another interesting finding is that size is always significantly negative for the

18

negative earnings sub-sample which is in contrast to all other regressions where size was included. This indicates that for firms that report negative earnings, there is a strong negative relationship between size and returns. The findings of the sub-sample analysis indicate that generally, the results of the multivariate regression analysis are not robust to whether firms report positive or negative earnings. Thus, the inferences drawn from the analysis on the full sample have to be downweighted. It is difficult to isolate the cause of these perverse results. To some degree, this is a function of the empirical research process in that if one runs enough permutations, eventually contrasting findings will be observed. Regardless, we place more emphasis on the findings on the full sample as this analysis is performed on the full spectrum of firms.

3.2.4 Turn of the Year Effect Several studies have documented that seasonality exists in stock returns in that stock returns tend be higher in January than in other months. In Australia it is documented that returns exhibit a peak in both January and July months (Brown, Keim, Kleidon and Marsh, 1983). To test whether our findings are driven by seasonal influences we replicate the original analysis by (a) excluding January and July; and, (b) excluding all other months other than January and July. Panel A of Table 7 reports the average returns (excluding January and July) for portfolios formed on B/M, S/P, D/E and size while Panel B reports the average returns for E/P+, E/P-, C/P+ and C/P- portfolios. The findings reported in Panels A and B are consistent with the full sample results reported in Table 1. Panel A of Table 8 reports the average returns (only January and July months) for portfolios formed on B/M, S/P, D/E and size while Panel B reports the average returns for E/P+, E/P-, C/P+ and C/P- portfolios. Although the returns are larger in magnitude for the January and July only months, the general direction is identical to the full sample results reported in Table 1. [Insert Tables 7 to 11 about here]

19

Panel A of Table 10 reports the results of the univariate FM regressions while Panels B and C report the univariate FM regressions of returns on positive E/P and C/P and negative E/P and C/P portfolios, respectively. Once again the results reported in Table 10 are comparable to the full sample results reported in Table 3. In Table 11 we report the results of the multivariate FM regressions. Our findings for the sample excluding January and July months are similar to the full sample results reported in Table 4. Thus, we reject the claim that the findings can be explained by the turn of the year effect.

4. Summary and Conclusions

Fama and French (1992) find that characteristics that can identify value and glamour firms such as the book-to-market ratio explain the cross-sectional variation in average equity returns better than the beta of a security. This finding led to the Fama and French (1993) three factor model which incorporates B/M as one the factors that explains cross-sectional variation in equity returns. Barbee et al. (1996) and Leledakis and Davidson (2001) suggest that other variables may exist that identify value/glamour firms and better predict average equity returns. Specifically, they show that the ratio of sales-to-price is superior to B/M in explaining the cross-sectional variation in equity returns. Other studies critical of Fama and French (1992) contend that the findings of Fama and French (1992) are due to data snooping and that the explanatory power of B/M is sample specific. The primary aim of this paper is to test these contentions by providing a comprehensive evaluation of possible value/glamour proxies namely, B/M, S/P, E/P and C/P. Hence, our study has two main objectives. They are (a) to test whether the value/glamour effect exists in Australia; and (b) to identify the variable(s) that best identify value/glamour firms and predict equity returns. Our findings can be summarised as follows: (a) a strong value/glamour effect exists in Australia; and (b) B/M is the superior proxy for value/glamour and best explains cross-sectional
20

variation in equity returns. Our findings also provide support for S/P as a good predictor of equity returns. Despite other value/glamour proxies exhibiting significant explanatory power, B/M is the only variable that consistently displays the highest level of significance after controlling for both size and D/E. This result is consistent with the findings of Fama and French (1992). Our results using non-U.S. and non-U.K. data produce relations between average returns and firm specific variables that are in principle consistent with those observed using U.S. and U.K. data, particularly in relation to the existence of a value/glamour effect. However, there is some discrepancy between our study and Barbee et al. (1996) and Leledakis and Davidson (2001) with regard to which variable is the superior proxy for value/glamour. The implications of this type of study for the practice of investment analysis are important. The academic work on value investing has had a strong impact on professional investment management. Value and glamour strategies are widely used by investment managers. The significance of the B/M variable suggests that it provides a good stock selection tool when forming investment strategies based on value and glamour in Australia. Our findings also support the widely used Fama and French (1993) model as B/M emerges as the best predictor for average equity returns.

21

References
Banz, R.W., 1981, The relationship between return and market value of common stocks. Journal of Financial Economics 9, 3-18. Barbee, W. C., Mukherji, S., and G. Raines, 1996, Do sales-price and debt-equity explain stock returns better than book-market and firm size? Financial Analysts Journal 52, 5660. Basu, S., 1983, The relationship between earnings yield, market value, and return for NYSE common stocks: Further evidence. Journal of Financial Economics 12, 129-156. Black, F., 1972, Capital market equilibrium with restricted borrowing. Journal of Business 45, 444-454. Black, F., 1993, Beta and return. Journal of Portfolio Management 20, 818. Brown, P., Keim, D., Kleidon, A., and T. Marsh, 1983, Stock returns, seasonalities, and the taxloss selling hypothesis: Analysis and arguments of the Australian evidence. Journal of Financial Economics 12, 33-56. Chan, H.W.H., and R.W. Faff, 2003, An investigation into the role of liquidity in asset pricing: Australian evidence. Pacific-Basin Finance Journal 11, 555-572. Chan, L.K., Hamao, Y., and J. Lakonishok, 1991, Fundamentals and stock returns in Japan. Journal of Finance 46, 1739-1789. Chin, J.Y.F., Prevost, A.K and A.A. Gottesman, 2002, Contrarian investing in a small capitalization market: Evidence from New Zealand. Financial Review 37, 421-446. Damodaran, A., 2002, Investment Valuation: Tools and techniques for determining the value of any asset. Wiley Finance, New York. Fama, E.F., and K.R. French, 1992, The cross-section of expected stock returns. Journal of Finance 47, 427-465. Fama, E.F., and K.R. French, 1993, Common risk factors in the returns on stocks and bonds. Journal of Financial Economics 33, 3-56. Fama, E.F., and K.R. French, 1998, Value versus growth: The international evidence. Journal of Finance 53, 1975-2000. Fama, E.F., and J. MacBeth, 1973, Risk, return, and equilibrium: Empirical tests. Journal of Political Economy 81, 607-636. Gaunt, C., 2004, Size and book to market effects and the Fama French three factor asset pricing model: Evidence from the Australian share market. Accounting and Finance 44, 27-44. Gharghori, P., Chan, H.W.H. and R.W. Faff, 2006. Default Risk and the Cross-Section of Equity Returns. Monash University Working Paper. Graham, B., and D. Dodd, 1934, Security analysis, McGraw-Hill, New York.
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Graham, B., 1973, The Intelligent Investor: The definitive book on value investing, Collins Business Essentials, New York. Halliwell, J., Heaney, J., and J. Sawicki, 1999, Size and book to market effects in Australian share markets: A time-series analysis. Accounting Research Journal 12, 122-137. Jaffe, J., Keim, D., and R. Westerfield, 1989, Earnings yields, market values and stock returns. Journal of Finance 44, 135-148. Kothari, S.P., Shanken, J., and R. Sloan, 1995, Another look at the cross-section of expected stock returns. Journal of Finance 50, 185-224. Lakonishok, J., Shleifer, A., and R.W. Vishny, 1994, Contrarian investment, extrapolation and risk. Journal of Finance 49, 1541-1578. La Porta, R., 1996, Expectations and the cross-section of stock returns. Journal of Finance 51, 1715-1742. La Porta, R., Lakonishok, J., Shleifer, A., and R. Vishny, 1997, Good news for value stocks: further evidence on market efficiency. Journal of Finance 52, 859-874. Leledakis, G. and I. Davidson, 2001, Are two factors enough? The UK evidence. Financial Analysts Journal 57, 96105. Lintner, J., 1965, The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economics and Statistics 47, 13-37. MacKinlay, A. C., 1995, Multifactor models do not explain deviations from CAPM. Journal of Financial Economics 38, 328. Kwag, S.W., and S.W. Lee, 2006, Value Investing and the Business Cycle. Journal of Financial Planning 19, 64-71. Sharpe, W.F., 1964, Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance 19, 425-442. White, H., 1980, A heteroskedasticity consistent covariance matrix and a direct test for heteroskedasticity. Econometrica 48, 817838.

23

Table 1 Returns and firm characteristics for portfolios formed using rankings on each of the variables
Panel A: B/M Returns B/M S/P D/E SIZE E/P C/P D1 0.96 0.082 0.605 0.355 410.8 -0.057 -0.020 D2 1.19 0.206 0.638 0.369 709.2 -0.057 -0.013 D3 1.01 0.318 0.884 0.585 1058.3 -0.040 0.004 D4 1.15 0.430 1.013 0.771 888.1 -0.028 0.020 D5 1.27 0.556 1.143 0.908 710.8 -0.031 0.022 D6 1.50 0.700 1.221 0.894 545.5 -0.024 0.029 D7 1.35 0.871 1.218 0.850 400.7 -0.035 0.011 D8 1.86 1.084 1.290 0.917 239.9 -0.040 0.015 D9 2.35 1.419 1.598 1.079 110.3 -0.070 0.006 D10 3.75 3.598 3.157 3.650 58.5 -0.174 0.067

Panel B: S/P Returns B/M S/P D/E SIZE E/P C/P D1 0.51 0.772 0.016 0.379 133.4 -0.090 -0.058 D2 1.04 0.815 0.071 0.320 462.3 -0.056 -0.024 D3 0.96 0.744 0.161 0.888 1464.8 -0.041 -0.004 D4 0.92 0.677 0.301 1.293 883.0 -0.032 0.012 D5 1.19 0.705 0.500 0.831 1069.0 -0.016 0.038 D6 1.45 0.760 0.797 0.757 1141.0 -0.002 0.043 D7 1.38 0.819 1.196 0.927 714.3 0.013 0.075 D8 1.50 0.981 1.787 1.257 463.0 0.024 0.089 D9 1.63 1.061 3.050 1.657 345.6 0.005 0.115 D10 2.74 1.987 9.395 4.643 68.5 -0.124 0.209

Panel C: D/E Returns B/M S/P D/E SIZE E/P C/P D1 1.26 0.582 0.038 0.009 44.2 -0.083 -0.059 D2 1.40 0.738 0.039 0.031 79.3 -0.104 -0.077 D3 2.02 0.812 0.106 0.069 140.8 -0.096 -0.066 D4 1.34 0.731 0.244 0.135 294.7 -0.067 -0.030 D5 1.45 0.691 0.466 0.234 463.1 -0.045 0.001 D6 1.44 0.723 0.750 0.363 669.2 -0.024 0.042 D7 1.49 0.760 1.112 0.545 844.0 -0.017 0.047 D8 1.50 0.864 1.666 0.829 887.2 -0.010 0.057 D9 1.72 1.071 2.782 1.406 449.2 -0.019 0.080 D10 2.62 2.290 5.573 6.756 1261.3 -0.091 0.146

Panel D: SIZE Returns B/M S/P D/E SIZE E/P C/P D1 6.78 2.142 2.040 2.402 2.3 -0.349 -0.093 D2 2.24 1.209 1.254 0.910 4.8 -0.205 -0.101 D3 0.65 0.920 1.332 0.771 8.0 -0.128 -0.041 D4 0.90 0.860 1.323 0.768 12.8 -0.065 -0.020 D5 0.54 0.816 1.468 0.827 20.8 -0.028 0.009 D6 0.85 0.783 1.373 0.856 35.1 0.011 0.046 D7 0.72 0.694 1.224 0.744 65.5 0.036 0.066 D8 1.00 0.682 1.054 0.783 141.6 0.055 0.087 D9 1.17 0.629 0.911 0.882 404.2 0.058 0.091 D10 1.10 0.527 0.792 1.429 4438.5 0.057 0.097

24

Table 1 (continued)
Panel E: E/P E/PQ1 E/P+ Returns 3.57 B/M 1.549 S/P 2.396 D/E 2.279 SIZE 13.9 E/P -0.874 C/P -0.334

Q2 2.02 0.947 0.720 0.629 28.4 -0.212 -0.138

Q3 1.53 0.813 0.404 0.393 42.4 -0.105 -0.080

Q4 0.98 0.704 0.372 0.314 53.9 -0.052 -0.036

Q5 0.46 0.588 0.403 0.290 150.1 -0.016 -0.008 Q1 0.89 0.623 0.820 0.590 748.0 0.021 0.040 Q2 1.18 0.615 1.035 0.708 1251.8 0.049 0.073 Q3 1.24 0.689 1.290 1.104 1210.7 0.070 0.095 Q4 1.60 0.827 1.827 1.216 807.5 0.095 0.132 Q5 2.67 1.859 3.032 2.537 409.0 0.280 0.266

Panel F: C/P C/PQ1 C/P+ Returns 3.32 B/M 1.386 S/P 1.670 D/E 1.682 SIZE 39.2 E/P -0.571 C/P -0.675

Q2 2.20 0.923 0.618 0.468 35.3 -0.183 -0.167

Q3 1.19 0.791 0.502 0.392 78.4 -0.113 -0.086

Q4 1.08 0.664 0.403 0.301 77.7 -0.065 -0.042

Q5 0.94 0.589 0.400 0.271 139.9 -0.025 -0.013 Q1 0.99 0.669 0.721 0.532 639.8 0.013 0.023 Q2 1.18 0.655 0.877 0.759 1110.8 0.043 0.062 Q3 1.19 0.679 1.235 0.901 1060.1 0.057 0.098 Q4 1.71 0.827 1.815 1.214 1054.8 0.065 0.157 Q5 2.71 1.977 3.926 3.327 503.0 0.115 0.581

This table reports monthly returns and average firm characteristics for portfolios formed using rankings on each of the six variables. Each month, from January 1993 to December 2004, the equally-weighted (next month) return and firm characteristic is calculated for each portfolio. The returns and firm characteristics reported in the table are the time-series average of the monthly portfolio returns (in percent) and the monthly firm characteristics. (Firm) size is reported in billions of dollars. Panels A, B, C and D present the monthly returns and firm characteristics on decile portfolios formed using rankings on B/M, S/P, D/E and size, respectively. Panels E and F present the monthly returns and firm characteristics on quintile portfolios formed using rankings on E/P+, E/P-, C/P+ and C/P-. D1 is the lowest decile portfolio and D10 is the highest decile portfolio. Similarly, Q1 is the lowest quintile portfolio and Q5 is the highest quintile portfolio.

25

Table 2 Correlation matrix for the transformed variables

SIZE 1.000 -0.194 0.196 -0.097 -0.501 0.270 -0.443 0.283 B/M 1.000 0.265 0.158 0.052 0.168 0.074 0.173 D/E S/P E/P+ E/PC/P+ C/P-

SIZE B/M D/E S/P E/P+ E/PC/P+ C/P-

1.000 0.355 -0.242 0.448 -0.168 0.474

1.000 -0.001 0.136 0.060 0.151

1.000 -0.685 0.520 -0.398

1.000 -0.322 0.561

1.000 -0.648

1.000

This table reports the time-series averages of monthly cross-sectional correlations between all six variables, covering the period January 1993 to December 2004. The variables used to construct this matrix are the transformed variables used for the regression analysis. Size is the natural logarithm of the firms market capitalisation; B/M is the natural logarithm of the book-to-market ratio; D/E is the natural logarithm of the debt-to-equity ratio; S/P is the natural logarithm of the sales-to-price ratio; E/P+ is the natural logarithm of positive earnings-to-price ratios; E/P- is the natural logarithm of the absolute value of negative earnings-to-price ratios; C/P+ is the natural logarithm of positive cash flowto-price ratios; and C/P- is the natural logarithm of the absolute value of negative cash flow-to-price ratios.

26

Table 3 Univariate Fama-MacBeth regressions of returns on each of the six variables

Panel A: Univariate FM Regressions Const Variable E/P+ B/M 0.0029 0.0060 (0.72) (5.65) S/P -0.0001 0.0029 (-0.02) (7.18) E/P 0.0024 -0.0003 (0.43) (-0.25) C/P 0.0059 (1.22) D/E 0.0049 0.0038 (1.46) (4.57) SIZE -0.0192 0.0010 (-1.03) (1.09)

E/P-

C/P+

C/P-

0.0060 (6.46) 0.0010 (1.05) 0.0056 (6.58)

Panel B: Univariate FM Regressions of Returns on Positive E/P and C/P Const Variable E/P+ 0.0212 0.0056 (6.15) (6.16) C/P+ 0.0189 0.0045 (6.02) (6.67)

Panel C: Univariate FM Regressions of Returns on Negative E/P and C/P Const Variable E/P-0.0093 0.0024 (-1.29) (2.51) C/P-0.0105 0.0019 (-1.50) (1.97) This table reports average FM regression estimates using individual firm data for all months of our sample period January 1993 to December 2004. In each month, a cross-sectional regression is estimated using OLS adjusted for Whites heteroskedasticity-consistent covariance matrix, wherein next months return is regressed on one of the six independent variables, in turn. The values reported in the table are the average time-series slope estimates which are obtained using Weighted Least Squares. The monthly slope estimates are weighted by the inverse of their standard error thereby giving more importance to slope estimates that are more precisely estimated. The associated t-statistics are reported in parentheses directly under the relevant mean slope estimate.

27

Table 4 Multivariate Fama-MacBeth regressions of returns on the group of variables specified

Const 0.0038 (0.95) 0.0069 (1.98) -0.0267 (-1.41) 0.005 (1.47) -0.0208 (-1.11) 0.0045 (0.79) -0.0095 (-0.54) -0.0034 (-0.19) 0.0228 (1.48) 0.0145 (0.92) -0.0128 (-0.72) 0.0269 (1.80) 0.0034 (0.60) 0.0135 (0.89) 0.0048 (5.77) 0.0047 (5.98) 0.0017 (4.94) 0.0017 (4.24) 0.0054 (6.61) 0.0018 (4.63) -0.0010 (-1.43) -0.0012 (-1.26) -0.0012 (-1.69) 0.0035 (5.44) 0.0032 (4.53) 0.0031 (4.96) 0.0004 (0.73) -0.0001 (-0.14) -0.0001 (-0.27) 0.0025 (5.11) 0.0018 (3.37) 0.0019 (4.27) -0.0001 (-0.15) -0.0005 (-0.71) 0.0056 (6.73) 0.0019 (4.79) -0.0009 (-1.12) 0.0045 (6.79) 0.0003 (0.48) 0.0042 (7.76) B/M 0.0054 (5.30) 0.0046 (5.23) 0.0069 (6.25) 0.0019 (4.33) 0.0029 (6.96) -0.0004 (-0.46) 0.0041 (5.47) 0.0011 (1.71) 0.003 (5.02) 0.0024 (3.71) 0.0029 (3.68) 0.0018 (2.97) 0.0020 (3.10) 0.0018 (2.54) 0.0012 (2.07) 0.0009 (1.08) 0.0004 (0.53) -0.0011 (-1.55) -0.0005 (-0.67) 0.0011 (1.29) -0.0012 (-1.85) 0.0032 (3.70) 0.0012 (1.29) S/P 0.0023 (6.81) E/P+ E/PC/P+ C/PD/E SIZE

(A)

B/M, S/P

(B)

B/M, D/E

0.0029 (3.87) 0.0017 (1.82)

(C)

B/M, SIZE

(D)

S/P, D/E

(E)

S/P, SIZE

(F)

E/P, C/P

(G)

B/M, D/E, SIZE

(H)

S/P, D/E, SIZE

(I)

E/P, D/E, SIZE

(J)

C/P, D/E, SIZE

(K)

B/M, S/P, D/E, SIZE

(L)

E/P, C/P, D/E, SIZE

(M)

B/M, S/P, E/P, C/P

(N)

ALL

This table reports average FM regression estimates using individual firm data for all months of our sample period January 1993 to December 2004. In each month, a cross-sectional regression is estimated using OLS adjusted for Whites heteroskedasticity-consistent covariance matrix, wherein next months return is regressed on the group of variables specified. The values reported in the table are the average time-series slope estimates which are obtained using Weighted Least Squares. The monthly slope estimates are weighted by the inverse of their standard error thereby giving more importance to slope estimates that are more precisely estimated. The associated t-statistics are reported in parentheses directly under the relevant mean slope estimate.
28

Table 5 Multivariate Fama-MacBeth regressions of returns on the group of variables specified positive earnings sub-sample
Const 0.0102 (3.76) 0.0109 (4.05) 0.0037 (0.30) 0.099 (3.66) 0.0053 (0.46) 0.0215 (5.80) 0.0074 (0.60) 0.0104 (0.89) 0.0152 (1.25) 0.0105 (0.89) 0.0073 (0.61) 0.0159 (1.34) 0.0212 (6.31) 0.0150 (1.26) 0.0005 (0.69) 0.0005 (0.75) 0.0004 (1.19) 0.0004 (1.10) 0.0015 (2.07) 0.0006 (1.63) 0.005 (6.74) 0.0055 (6.99) 0.0052 (6.74) 0.0000 (-0.09) -0.0002 (-0.41) -0.0002 (-0.42) 0.0004 (0.82) 0.0003 (0.54) 0.0014 (1.94) 0.0005 (1.41) 0.0054 (6.74) 0.0004 (0.95) B/M 0.0018 (2.29) 0.0014 (1.77) 0.0021 (2.66) 0.0004 (0.93) 0.0013 (3.47) 0.0058 (6.45) 0.0000 (0.03) 0.0015 (3.48) 0.0017 (3.37) 0.0006 (1.27) 0.0018 (3.62) 0.0014 (2.92) 0.0006 (1.30) 0.0001 (0.24) -0.0001 (-0.09) 0.0002 (0.39) -0.0001 (-0.15) 0.0002 (0.31) 0.0002 (0.29) 0.0018 (3.62) 0.0002 (0.28) S/P 0.0011 (2.58) E/P+ E/PC/P+ C/PD/E SIZE

(A)

B/M, S/P

(B)

B/M, D/E

0.0017 (3.77) 0.00037 (0.50)

(C)

B/M, SIZE

(D)

S/P, D/E

(E)

S/P, SIZE

(F)

E/P, C/P

(G)

B/M, D/E, SIZE

(H)

S/P, D/E, SIZE

(I)

E/P, D/E, SIZE

(J)

C/P, D/E, SIZE

(K)

B/M, S/P, D/E, SIZE

(L)

E/P, C/P, D/E, SIZE

(M)

B/M, S/P, E/P, C/P

(N)

ALL

This table reports average FM regression estimates using individual firm data for all months of our sample period January 1993 to December 2004. In each month, a cross-sectional regression is estimated using OLS adjusted for Whites heteroskedasticity-consistent covariance matrix, wherein next months return is regressed on the group of variables specified. The values reported in the table are the average time-series slope estimates which are obtained using Weighted Least Squares. The monthly slope estimates are weighted by the inverse of their standard error thereby giving more importance to slope estimates that are more precisely estimated. The associated t-statistics are reported in parentheses directly under the relevant mean slope estimate. Only firms that report positive earnings in a given year are included in this sample.
29

Table 6 Multivariate Fama-MacBeth regressions of returns on the group of variables specified negative earnings sub-sample
Const -0.0074 (-1.20) -0.0063 (-1.07) 0.1058 (4.42) -0.078 (-1.35) 0.1193 (5.01) -0.0086 (-1.20) 0.1036 (4.38) 0.1165 (4.94) 0.1355 (6.09) 0.1207 (5.11) 0.1011 (4.28) 0.1358 (6.09) -0.0067 (-0.93) 0.1588 (5.17) 0.0081 (7.32) 0.0063 (6.02) 0.0020 (4.30) 0.0016 (3.15) 0.0061 (5.82) 0.0017 (3.20) -0.0026 (-3.00) 0.0008 (0.83) -0.0024 (-2.77) 0.0008 (1.40) -0.0002 (-0.23) 0.0002 (0.29) 0.0005 (0.65) -0.0007 (-6.48) 0.0065 (6.15) 0.0020 (3.85) -0.0024 (-2.86) 0.0002 (0.37) B/M 0.0081 (6.71) 0.0086 (7.65) 0.0068 (5.74) 0.0031 (5.69) 0.0022 (4.48) 0.0019 (1.98) 0.014 (1.97) 0.0002 (0.21) 0.0009 (1.10) 0.0019 (2.36) 0.0015 (1.92) -0.0001 (-0.17) 0.0017 (2.23) -0.0067 (-5.44) -0.0077 (-6.24) -0.0091 (-7.75) -0.0079 (-6.38) -0.0066 (-5.31) -0.0091 (-7.70) 0.0009 (1.08) -0.0080 (-6.42) S/P 0.0022 (4.65) E/P+ E/PC/P+ C/PD/E SIZE

(A)

B/M, S/P

(B)

B/M, D/E

0.0000 (-0.06) -0.0069 (-5.57)

(C)

B/M, SIZE

(D)

S/P, D/E

(E)

S/P, SIZE

(F)

E/P, C/P

(G)

B/M, D/E, SIZE

(H)

S/P, D/E, SIZE

(I)

E/P, D/E, SIZE

(J)

C/P, D/E, SIZE

(K)

B/M, S/P, D/E, SIZE

(L)

E/P, C/P, D/E, SIZE

(M)

B/M, S/P, E/P, C/P

(N)

ALL

This table reports average FM regression estimates using individual firm data for all months of our sample period January 1993 to December 2004. In each month, a cross-sectional regression is estimated using OLS adjusted for Whites heteroskedasticity-consistent covariance matrix, wherein next months return is regressed on the group of variables specified. The values reported in the table are the average time-series slope estimates which are obtained using Weighted Least Squares. The monthly slope estimates are weighted by the inverse of their standard error thereby giving more importance to slope estimates that are more precisely estimated. The associated t-statistics are reported in parentheses directly under the relevant mean slope estimate. Only firms that report negative earnings in a given year are included in this sample.
30

Table 7 Returns on decile portfolios formed using rankings on each of the variables not including January and July
Panel A D1 B/M S/P D/E SIZE 0.81 0.43 1.16 6.54

D2 0.95 0.88 1.34 1.88

D3 0.96 0.92 1.87 0.46

D4 1.02 0.85 1.14 0.67

D5 1.25 1.14 1.23 0.42

D6 1.25 1.20 1.32 0.73

D7 1.19 1.32 1.32 0.59

D8 1.70 1.40 1.39 0.93

D9 2.33 1.56 1.63 1.20

D10 3.55 2.55 2.47 1.16

Panel B Q1 E/P+ E/PC/P+ C/P2.96 3.28

Q2

Q3

Q4

Q5

Q1 0.80

Q2 1.09

Q3 1.12

Q4 1.41

Q5 2.38

1.85

1.43

0.96

0.32 0.94 1.00 1.08 1.61 2.58

2.05

1.00

1.04

0.72

This table reports monthly returns on portfolios formed using rankings on each of the six variables. Each month, from January 1993 to December 2004, the equally-weighted (next month) return is calculated for each portfolio. The returns reported in the tables are the time-series average of the monthly portfolio returns (in percent). Panel A presents the monthly returns on decile portfolios formed using rankings on the B/M, S/P, D/E and size variables. Panel B presents the monthly returns on quintile portfolios formed using rankings on the E/P+, E/P-, C/P+ and C/P- variables. D1 is the lowest decile portfolio and D10 is the highest decile portfolio. Similarly, Q1 is the lowest quintile portfolio and Q5 is the highest quintile portfolio. The returns in the months of January and July have been excluded.

31

Table 8 Returns on decile portfolios formed using rankings on each of the variables January and July only
Panel A D1 B/M S/P D/E SIZE 1.72 0.92 1.76 7.99

D2 2.38 1.82 1.75 4.05

D3 1.26 1.17 2.73 1.61

D4 1.80 1.29 2.32 2.03

D5 1.37 1.40 2.57 1.11

D6 2.76 2.72 2.06 1.43

D7 2.12 1.64 2.33 1.39

D8 2.65 2.03 2.06 1.37

D9 2.45 1.93 2.19 1.03

D10 4.71 3.71 3.35 0.75

Panel B Q1 E/P+ E/PC/P+ C/P5.05 5.00

Q2

Q3

Q4

Q5

Q1 1.33

Q2 1.60

Q3 1.88

Q4 2.55

Q5 4.14

2.91

2.03

1.05

1.17 1.23 2.05 1.71 2.22 3.41

2.95

2.18

1.28

2.07

This table reports monthly returns on portfolios formed using rankings on each of the six variables. Each month, from January 1993 to December 2004, the equally-weighted (next month) return is calculated for each portfolio. The returns reported in the tables are the time-series average of the monthly portfolio returns (in percent). Panel A presents the monthly returns on decile portfolios formed using rankings on the B/M, S/P, D/E and size variables. Panel B presents the monthly returns on quintile portfolios formed using rankings on the E/P+, E/P-, C/P+ and C/P- variables. D1 is the lowest decile portfolio and D10 is the highest decile portfolio. Similarly, Q1 is the lowest quintile portfolio and Q5 is the highest quintile portfolio. The returns in all months except January and July have been excluded.

32

Table 9 Correlation matrix for the transformed variables not including January and July
SIZE 1.000 -0.218 0.185 -0.098 -0.502 0.255 -0.446 0.270 B/M 1.000 0.282 0.179 0.061 0.177 0.086 0.183 D/E S/P E/P+ E/PC/P+ C/P-

SIZE B/M D/E S/P E/P+ E/PC/P+ C/P-

1.000 0.363 -0.234 0.453 -0.161 0.482

1.000 -0.013 0.145 0.053 0.162

1.000 -0.671 0.529 -0.392

1.000 -0.315 0.566

1.000 -0.638

1.000

This table reports the time-series averages of monthly cross-sectional correlations between all six variables, covering the period January 1993 to December 2004. The variables used to construct this matrix are the transformed variables used for the regression analysis. Size is the natural logarithm of the firms market capitalisation; B/M is the natural logarithm of the book-to-market ratio; D/E is the natural logarithm of the debt-to-equity ratio; S/P is the natural logarithm of the sales-to-price ratio; E/P+ is the natural logarithm of positive earnings-to-price ratios; E/P- is the natural logarithm of the absolute value of negative earnings-to-price ratios; C/P+ is the natural logarithm of positive cash flow-to-price ratios; and C/P- is the natural logarithm of the absolute value of negative cash flow-toprice ratios. The months of January and July have been excluded.

33

Table 10 Univariate Fama-MacBeth regressions of returns on each of the six variables not including January and July
Panel A: Univariate FM Regressions Const Variable E/P+ B/M 0.0016 0.0062 (0.36) (4.95) S/P -0.0017 0.0028 (-0.37) (6.33) E/P 0.0016 -0.0003 (0.26) (-0.23) C/P 0.0051 (0.95) D/E 0.0036 0.0037 (0.96) (3.90) SIZE -0.0289 0.0015 (-1.39) (1.48)

E/P-

C/P+

C/P-

0.0059 (5.60) 0.0010 (0.93) 0.0057 (5.69)

Panel B: Univariate FM Regressions of Returns on Positive E/P and C/P Const Variable E/P+ 0.0181 0.0051 (4.92) (5.00) C/P+ 0.0181 0.0046 (5.25) (6.03)

Panel C: Univariate FM Regressions of Returns on Negative E/P and C/P Const Variable E/P-0.0086 0.0025 (-1.06) (2.24) C/P-0.0110 0.0018 (-1.40) (1.63) This table reports average FM regression estimates using individual firm data for a subset of months of our sample period January 1993 to December 2004. In each month, a cross-sectional regression is estimated using OLS adjusted for Whites heteroskedasticity-consistent covariance matrix, wherein next months return is regressed on one of the six independent variables, in turn. The values reported in the table are the average time-series slope estimates which are obtained using Weighted Least Squares. The monthly slope estimates are weighted by the inverse of their standard error thereby giving more importance to slope estimates that are more precisely estimated. The associated t-statistics are reported in parentheses directly under the relevant mean slope estimate. The months of January and July have been excluded.

34

Table 11 Multivariate Fama-MacBeth regressions of returns on the group of variables specified not including January and July
Const 0.0025 (0.55) 0.0056 (1.46) -0.0306 (-1.46) 0.037 (0.97) -0.0306 (-1.46) 0.0036 (0.58) -0.0212 (-1.09) -0.0140 (-0.73) 0.0103 (0.60) 0.0033 (0.19) -0.0244 (-1.25) 0.0146 (0.88) 0.0028 (0.44) 0.0012 (0.07) 0.0048 (5.09) 0.0050 (5.64) 0.0016 (4.44) 0.0017 (4.08) 0.0057 (6.17) 0.0018 (4.38) -0.0007 (-0.96) -0.0012 (-1.16) -0.0009 (-1.17) 0.0035 (4.93) 0.0031 (3.93) 0.0031 (4.51) 0.0005 (0.78) -0.0002 (-0.33) -0.0001 (-0.16) 0.0027 (4.83) 0.0018 (3.04) 0.0021 (4.12) -0.0004 (-0.55) 0.0002 (0.24) 0.0059 (6.29) 0.0019 (4.55) -0.0005 (-0.59) 0.0046 (6.22) 0.0006 (0.82) 0.0044 (7.14) B/M 0.0055 (4.68) 0.0047 (4.58) 0.0029 (6.24) 0.0018 (3.81) 0.0029 (6.24) -0.0004 (-0.43) 0.0039 (4.73) 0.0009 (1.30) 0.030 (4.36) 0.0022 (2.94) 0.0028 (3.00) 0.0016 (2.31) 0.0017 (2.37) 0.0015 (1.92) 0.0010 (1.47) 0.0015 (1.61) 0.0010 (1.05) -0.0004 (-0.52) 0.0001 (0.11) 0.0017 (1.80) -0.0006 (-0.79) 0.0032 (3.16) 0.0016 (1.65) S/P 0.0022 (6.15) E/P+ E/PC/P+ C/PD/E SIZE

(A)

B/M, S/P

(B)

B/M, D/E

0.0028 (3.28) 0.0016 (1.65)

(C)

B/M, SIZE

(D)

S/P, D/E

(E)

S/P, SIZE

(F)

E/P, C/P

(G)

B/M, D/E, SIZE

(H)

S/P, D/E, SIZE

(I)

E/P, D/E, SIZE

(J)

C/P, D/E, SIZE

(K)

B/M, S/P, D/E, SIZE

(L)

E/P, C/P, D/E, SIZE

(M)

B/M, S/P, E/P, C/P

(N)

ALL

This table reports average FM regression estimates using individual firm data for a subset of months of our sample period January 1993 to December 2004. In each month, a cross-sectional regression is estimated using OLS adjusted for Whites heteroskedasticity-consistent covariance matrix, wherein next months return is regressed on the group of variables specified. The values reported in the table are the average time-series slope estimates which are obtained using Weighted Least Squares. The monthly slope estimates are weighted by the inverse of their standard error thereby giving more importance to slope estimates that are more precisely estimated. The associated t-statistics are reported in parentheses directly under the relevant mean slope estimate. The months of January and July have been excluded.
35