Stocks Returns Investment Analysis - Essay Example

Investment Analysis Introduction This article is intended to analyze the excess returns of 6 stocks from the S&P/ASX300. Those stocks are as follows: Myer Holdings Limited (MYR) Tabcorp Holdings Limited (TAH) BHP Billiton Ltd. (BHP) QBE Insurance Group Ltd. (QBE) David Jones Ltd. (DJS) Qantas Airways Limited (QAN) The above mentioned stocks are picked on random basis so that the analysis overall should not emphasize one or two industries. The excess returns of these stocks are identified by applying the Three Factor Model given by Fama and French in 1993. This model postulates that a given stock’s excess return is mainly dependent upon three factors which are as follows: Excess Market Return (EMR) Small Company Returns minus Big Company Returns (SMB) High Market-to-Book Company Returns minus Low Market-to-Book Company Returns (HML) Analysis The following is the analysis of the companies in the light of Fama and French’s “Three Factor Model”. Myer Holdings Limited Regression Statistics Multiple R 0.6871 R Square 0.4722 Adjusted R Square 0.3968 Standard Error 7.0065 Observations 25   Coefficients Standard Error t Stat P-value Intercept -0.6994 1.4381 -0.4864 0.6318 EMR 1.7091 0.3996 4.2770 0.0003 SMB -0.1853 0.7623 -0.2430 0.8103 HML 1.6162 0.9674 1.6706 0.1096 The value of R-square suggests that all variable have explained the excess returns of MYR by 47.22% which is a moderate percentage. If the intercept of the equation is analyzed, it can be observed that it is insignificant because p-valued computed is higher than the critical value of the 0.05 level of significance. Excess marker return is the best predictor among the three variables, so that it has predicted a beta coefficient of 1.7, which means that the stock is quite risky as it 0.7 time more than that of the market. However, SMB and HML did not effectively predict the excess returns of MYR as their values are higher than the critical values. Tabcorp Holdings Limited Regression Statistics Multiple R 0.3745 R Square 0.1402 Adjusted R Square 0.0174 Standard Error 18.1289 Observations 25   Coefficients Standard Error t Stat P-value Intercept -2.4335 3.7210 -0.6540 0.5202 EMR 1.5331 1.0339 1.4827 0.1530 SMB 1.2352 1.9725 0.6262 0.5379 HML -0.2313 2.5031 -0.0924 0.9273 The model fit of TAH reflects that it is not quite good as hardly 14% of the stock return is explained by the model. Another interesting thing that can be noticed is that all the three variables of the Three Factor Model are unable to predict the excess returns of TAH as all of them having p-values higher than the critical values of 0.05 which is the significant level. Hence, the excess return of the TAH is found to be independent of the Three Factor Model. BHP Billiton Ltd Regression Statistics Multiple R 0.8805 R Square 0.7754 Adjusted R Square 0.7433 Standard Error 3.2396 Observations 25   Coefficients Standard Error t Stat P-value Intercept 0.3361 0.6649 0.5055 0.6185 EMR 1.3838 0.1848 7.4898 0.0000 SMB -0.5223 0.3525 -1.4819 0.1532 HML -0.6844 0.4473 -1.5300 0.1409 If the model fit of BHP is observed, it can inferred that the overall model fit is quite strong as it presents that around 77% of excess returns of BHP are explained by the Three Factor Model. If individual factors are analyzed, it can be noticed that intercept remained insignificant due to higher p-value statistics. EMR has come out as the best predictor indicating a beta coefficient of 1.38, which reflects that the stock is 38% more risky than the market. Other two variables lacked in explaining the excess returns of BHP as their p-values turned out to be quite high than their critical values. QBE Insurance Group Ltd Regression Statistics Multiple R 0.5816 R Square 0.3383 Adjusted R Square 0.2438 Standard Error 5.7435 Observations 25   Coefficients Standard Error t Stat P-value Intercept -2.1797 1.1788 -1.8490 0.0786 EMR 0.6843 0.3276 2.0889 0.0491 SMB 0.9477 0.6249 1.5166 0.1443 HML -0.3833 0.7930 -0.4833 0.6339 A less moderate value of R-square for QBE reflects that the excess returns are explained by 33% by the overall model. If other variables are taken into account, it can be noticed that only EMR resulted in explaining the excess returns of QBE as provided by a beta coefficient of 0.68, which indicates that the stock is less risky as compared to market overall. SMB and HML could not determine the patterns of excess stock returns of QBE as indicated by their corresponding higher p-values. David Jones Ltd Regression Statistics Multiple R 0.6554 R Square 0.4295 Adjusted R Square 0.3480 Standard Error 7.8120 Observations 25   Coefficients Standard Error t Stat P-value Intercept -1.2246 1.6034 -0.7638 0.4535 EMR 1.7197 0.4455 3.8599 0.0009 SMB -0.6941 0.8500 -0.8166 0.4234 HML 1.0482 1.0786 0.9718 0.3422 The model fit of DJS is relatively moderate, so that around 43% of the excess returns of DJS are explained by the Three Factors Model on a joint basis. In their individual capacities, it can be observed that EMR is turned out to be a better predictor due to lower p-value. The beta coefficient of 1.77 reflects that the company is quite risky. The other two variables SMB and HML have shown higher p-values, therefore they are unable to predict the excess returns of DJS. Qantas Airways Limited Regression Statistics Multiple R 0.8059 R Square 0.6495 Adjusted R Square 0.5994 Standard Error 5.3127 Observations 25   Coefficients Standard Error t Stat P-value Intercept -0.9644 1.0904 -0.8844 0.3865 EMR 1.7613 0.3030 5.8130 0.0000 SMB 1.2013 0.5780 2.0782 0.0501 HML 1.1582 0.7335 1.5789 0.1293 The higher value of R-square suggests that the excess returns of QAN are 65% explained by the model fit. If individual variables are considered, it can be analyzed that EMR has explained the best with the beta coefficient of 1.76 indicating the company as a bit risky stock. The p-value of SMB is approximately equal to the critical value of 0.05 with the coefficient of 1.2 suggesting that the company is a small cap as it is greater than the critical value of 0.5. However, HML could not explain well due its higher p-value. Recommendations The above analysis shows that the excess returns of four stocks, namely MYR, BHP, QBE and DJS, are explained by the excess market returns only. The stock TAH showed a relatively independent excess return behavior, so that none of the Three Factors determined its excess returns behavior. QAN’s excess returns are, however, predicted by excess market returns and SMB. It is recommended that except TAH, all other 5 stocks should be taken into consideration for the portfolio construction. TAH should be avoided as its excess returns behavior is quite volatile and does not have any pattern. References Estrada, J. (2011). The Three Factor Model: a practitioner's guide. Journal of Applied Corporate Finance . p. 76-85. Faff, R. (2004). A simple test of the Fama and French Model using daily data: Australian evidence. Applied Financial Economics. 14 p. 83-92. Read More