The Performance Of Value Stocks Vs. Growth Stocks: Evaluating The Fama-French Five-Factor Model

Misgivings in Growth Stocks and Benefits provided by Value Stocks

Question:

Discuss about the Circle of Investment and Portfolio Management.

The researcher in the article mainly indicates the performance of value stock in accordance with growth stocks. The researcher highlighted the misgivings in growth stock and benefits provided by value stocks. In addition, the researcher pointed out the investors in expectation of higher return from growth stock increase its value, which does not occur at last. The researcher has conducted relevant evaluation and detect the validity of capital asset pricing model. Moreover, the financial performance of the companies consists of growth stock do not provide all the relevant return to the shareholder. On the other hand, the researcher pointed out the value stock being undervalued can provide high return from investment to the investors. The researcher also pointed out the financial performance of value stock were more than growth stocks, as founded in US Stocks (Chandra 2017).

Fama-French states relevant factors for analysing the overall financial performance of the company and detect overall growth, which could increase return from investment. Moreover, Fama-French mainly states that two factors are needed for analysing the overall average return of the stocks. The factors are market risk factors and value growth risk factor, which is indicated by Fama-French that the use of both the factors could help in detecting the actual returns from investment. The identified factors might help in detecting the actual returns of the company, which might allow the investor to identify stock with least returns. The value growth factors are mainly detected by differentiating between international portfolio of high book-to-market stock and the return provided by portfolios with low book-to-market stocks. In this context, Pagdin and Hardy (2017) mentioned that Fama-French models is helpful in detecting stock with the low risk, which could help in geniting high level of return from investment.

The Fama-French model mainly focuses its overall risk measure on two different forms, which could help in detecting stocks returns and increase profits from investments. The risk attributes are market risk factor and a value-growth risk factor, which is needed for analysing the actual risk hindering operational capability of the company. Moreover, CAPM model mainly focuses on one factor, which does not help in detecting the actual financial position of the company. Furthermore, the risk implementation of Fama-French might help in generating high level of profits. The market risk factor helps in evaluating the actual returns from investment, which could be provided by a stock. In addition, the value-growth factor would allow investors in detection the actual value of stock and the return it could provide from investment (Kashyap 2016).

CAPM model mainly has relevant implications to the investors, which help in detecting the risk and return from investment. In addition, the CAPM model helps in determining the return and risk in stocks. This might help in detecting return and risk involved in investments of the company, which might allow investors to generate high level of returns. Raab and Stahn (2017) stated that CAPM model evaluates beta and expected return of stocks, which is essential to create portfolio with low risk and high returns.

Analyzing Financial Performance using Fama-French Model

Moreover, the Fama-French model is used in evaluating examine multi-factor models, which could help in detecting risk that could impact expected return of stock. In addition, the Fama-French model evaluates two additional dimensions of risk that get rewarded nature of returns. The second implications are that value stock have higher returns than growth stock in the market all around the world. Moreover, the earnings-to-price, cash flow-to price and dividend-to-price is evaluated for detecting the actual financial capability of the stock to generate high returns.

The overall academic paper “The Five-Factor Fama-French Model: International Evidence” writer by Nusret Cakici, states the impact of Fama-French Model in detecting returns of the stock (Cakici 2015). In addition, the financial market of 23 countries are mainly evaluated to determine financial performance of the organisation. Moreover, the researcher in academic paper has effectively depicted the overall use of five-factor model, which could help in detecting the financial performance of the organisation. Furthermore, the data used from 23 stock market is evaluated based on Fama-French Model for determining the impact of extra two factors, whether they add explanatory power or a much weaker in Japan and Asian portfolios. The research paper mainly evaluates the gross profitability and investment factors include in Five-Factor Fama-French Model and whether its calculation could help in understanding the return form investment.

The discussion section of the academic paper in panel A that mainly indicates the intercepts from the Fama-French three-factor regressions for the 25 size-book-to-market portfolios. In addition, the panel B section provides intercepts from the Fama-French five-factor regressions, and their t-statistics. Both the analysis part might help in detecting the financial viability of Fama-French three-factor and Fama-French five-factor. The regression analysis mainly helps in detecting that lower number of significant alphas, which could help in detecting performance of the model. The results of the regression analysis mainly help in understanding the significance of alphas for the 5-factor model and 3-factor model. This relatively helps in identifying the financial performance of the company. However, the academic paper indicates that 5-factor model does not provide adequate measure or better description of average returns than three-factor model for the portfolios. This relatively indicates that the three-factor model is sufficient for the analysis of the return provide by the portfolios (Cakici 2015).

However, from the evaluation it could be detected that five-factor model is considered doubtful for major of the countries such as Japan and Asia-Pacific. However, the academic paper also states that three-factor model is much better option for the investors, as it applies to all the territories of the world and allows investor to detect actual return that will be provide from investment (Cakici 2015). Moreover, the objective of academic paper is to detect the impact of gross profitability and investment, as a relevant factor of five-factor Fame-French model. In addition, the researcher indicates that the new factors do not have any explanatory power for the stocks listed in Japan and Asia Pacific. The academic paper sheds light on the five-factor Fame-French model and how it could not provide all the relevant help to the investor in different reigns of the world.

Factors for Analyzing Overall Financial Performance

The researcher focuses on the results obtained from the academic paper, which states that five-factor Fame-French model perform much better in regional condition in comparison with the global condition. Furthermore, the academic paper’s outcome indicates that markets all around the world are not fully integrated, which relatively reduces the impact of five-factor Fame-French model on different markets all around the world. However, from the evaluation it could be detected that the five-factor Fame-French model has fairly performed in US market. The calculation of SMB, HML, RMW, and CMA is conducted in the research report, which might help in depicting the overall significance of five-factor Fame-French model. The researcher has used T-test, correlation, and other statistical tools for deriving the relationship between the calculation of different five-factor of Fame-French model.

The result section of the academic paper mainly indicates the correlation between Global, North America and Europe, which helps in deriving the efficiency and attractiveness of five-factor Fame-French model in identifying the stock with high value. However, the result also indicates that correlation between Japan and Asia Pacific are relatively different in comparison with Global, North America and Europe markets. This relatively indicates the vulnerability of five-factor Fame-French model in identifying the stock with high value, which could be used by investors.

Moreover, the academic paper sheds light on the fact that five-factor Fame-French model is not always the best possible options for evaluation. This derivation is concluded by evaluating the 25 size-book-to-market portfolios, the 25 size-GP portfolios, and the 25 size-Investment portfolios, where their applicability is in doubt for other regions of the world. The researcher indicates that the five-factor Fame-French model is not a viable approach for other countries or regions of the world, as it would not provide the accurate data for the evaluation. The result also evaluates the impact of RMW, CMA and HML, which could help investors in their decision-making process. Moreover, from the valuation it could be detected that RMW and CMA has smaller magnitude than HML, which might not help in detecting the actual return capability of the stock.

The results of the research also evaluate the Asset pricing test, which relatively suggest that Five Factor Model is not an adequate model for investor. According to the Asset pricing test, GP portfolios, size investment portfolios and size-book-to-market portfolios has not performed adequately and indicates that they cannot function in other regions of the world. However, from the valuation it is also indicated that asset pricing test suggest that regional factors always perform better in comparison to the Global factors. this indicates that the use of Five Factor Fama French model could eventually allow investing to support their investing me within the regional limits. This would eventually help in improving the return generation capacity of the investors. The researcher also portrays that the use of Fama French model could allow investors to support the investing needs nationally, while the problems might rise during the international investment schemes. Lastly, the academic paper possess doubt on the applicability of Five Factor Model in performing adequately all around the world. The research also states that viability of the model falls when investing in the markets of Japan and Asia Pacific. This relatively limits the capability of Five Factor Model in supporting investors during their investment schemes.

Depicting the expected return and standard deviation of the minimum-variance portfolio:

From the above table, standard deviation of the portfolio is calculated, which is at the levels of 20.56%. The standard deviation is detected by detecting the overall reward to variability ratio for identifying the actual risk involved in investment. Moreover, the use of optimal CAL has helped in identifying the overall standard deviation of the portfolio. Stettina and Horz (2015) stated that the detection of risk is essential to understand the risk to reward ratio provided from investment.

The calculation of T-bill portion in the portfolio is detected by using the means of any portfolio along with optimal CAL. This has helped in detecting the actual funds of the portfolio, which consist of T=bill fund. The 11.92% of the fund is contributed by T-bill, which could help in reducing risk from investment. Aouni, Colapinto and La (2014) mentioned that investors by exposing their portfolio with T-bills can reduce risk, which enables them to accommodate high risk and yield investments.

Reference and Bibliography:

Aouni, B., Colapinto, C. and La Torre, D., 2014. Financial portfolio management through the goal programming model: Current state-of-the-art. European Journal of Operational Research, 234(2), pp.536-545.

Cakici, N., 2015. The five-factor Fama-French model: International evidence.

Chandra, P., 2017. Investment analysis and portfolio management. McGraw-Hill Education.

DeFusco, R.A., McLeavey, D.W., Pinto, J.E., Anson, M.J. and Runkle, D.E., 2015. Quantitative investment analysis. John Wiley & Sons.

Kashyap, R., 2016. The Circle of Investment: Connecting the Dots of the Portfolio Management Cycle… arXiv preprint arXiv:1603.06047.

Pagdin, I. and Hardy, M., 2017. Investment and Portfolio Management: A Practical Introduction. Kogan Page Publishers.

Raab, M. and Stahn, S., 2017. Beyond smart beta: Index investment strategies for active portfolio management. John Wiley & Sons.

Stettina, C.J. and Hörz, J., 2015. Agile portfolio management: An empirical perspective on the practice in use. International Journal of Project Management, 33(1), pp.140-152.

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