As a follow up to the factors we explored previously, I wanted to share some very high level analysis I did on various implementations of Long Only Factor portfolios using non-traditional return drivers, such as…
| Return Driver | Category | Core Idea | How it is measured | Ideal Values are… |
|---|---|---|---|---|
| High EBIT / EV | Growth | Earnings before interest and taxes relative to enterprise value | EBIT divided by enterprise value | High |
| FCF/Price | Value | Free cash flow relative to stock price | Free cash flow divided by stock price | High |
| Cash/Assets | Value | Proportion of assets held in cash | Cash divided by total assets | High |
| Inventory Change | Fundamentals | Efficiency of inventory management | Change in inventory over a period | High |
| Asset Turnover | Fundamentals | Efficiency of asset utilization | Revenue divided by average assets | High |
| ROE | Fundamentals | Profitability relative to shareholder equity | Net income divided by shareholder equity | High |
| ROA | Fundamentals | Profitability relative to total assets | Net income divided by total assets | High |
| FCF Per Share | Fundamentals | Amount of free cash flow generated per share | Free cash flow divided by number of shares | High |
| EBITDA Margin | Fundamentals | Operating profitability excluding certain expenses | EBITDA divided by revenue | High |
| ROCE | Fundamentals | Efficiency of capital employed | Earnings before interest and taxes divided by capital employed | High |
| Momentum | Technical/Price | Price trend indicating continued performance in the same direction | Rate of change in price over time | High |
| Low Beta | Technical/Price | Lower beta compared to market | Measure of systematic risk relative to market | Low |
| Low Vol | Technical/Price | Lower volatility compared to market | Measure of standard deviation of returns | Low |
| Price/Sales | Technical/Price | Ratio of market capitalization to total sales | Market capitalization divided by total sales | High |
For each of these return drivers above, I rank all companies in the S&P 500 from best to worst and go long the top 10, rebalancing each month. For example for the first return driver - EBIT / EV - every month I am ranking companies based this ratio and because the “Ideal Values” are high values, I sort companies by EBIT/EV from high to low and go long the “best” 10.
The investment universe is companies in the S&P 500 at the given time in the backtest, who have at least 1 year of price data, and who are not in the top 10% of firms ranked by Beta. There’s evidence to suggest that extremely high beta firms generally don’t do well in the long run so I filter those out across all tests. The backtest periods are from 1 January 2000 to 1 July 2023. I won’t be sharing the nitty gritty details of these factors and their construction but the outcomes in general are indicative I think…
| Avg. Ann. Return | Avg. Ann. Std | Annual Sharpe | Worst Loss 1Y | Winning Years | |
|---|---|---|---|---|---|
| Inventory Change | 10.30% | 20.50% | 0.50 | -52.11% | 79.17% |
| Asset Turnover | 11.52% | 14.74% | 0.78 | -29.84% | 87.50% |
| ROE | 11.42% | 17.08% | 0.67 | -25.21% | 79.17% |
| ROA | 9.90% | 19.56% | 0.51 | -49.22% | 83.33% |
| EBIT/EV | 9.32% | 25.21% | 0.37 | -52.24% | 75.00% |
| FCF Per Share | 12.92% | 29.92% | 0.43 | -96.46% | 79.17% |
| EBITDA Margin | 8.76% | 23.35% | 0.38 | -62.64% | 70.83% |
| FCF/Price | 10.34% | 29.09% | 0.36 | -70.58% | 62.50% |
| Low Beta | 8.87% | 11.03% | 0.80 | -23.18% | 83.33% |
| ROCE | 7.36% | 17.63% | 0.42 | -54.32% | 83.33% |
| Momentum | 7.37% | 24.29% | 0.30 | -77.60% | 75.00% |
| Low Vol | 10.17% | 11.43% | 0.89 | -13.87% | 75.00% |
| Cash/Assets | 8.95% | 24.97% | 0.36 | -73.99% | 70.83% |
| Price/Sales | 10.35% | 28.25% | 0.37 | -71.79% | 75.00% |
Of course if you were to implement these yourself, I recommend doing your own research (standard “This is not financial advice” disclaimer here). It’s also important to reiterate that these are 10-position long only portfolios so your mileage will vary if you add more stocks.