An Empirical Study of A Rule Based Stock Selection Method To Generate Alpha

Abstract

This paper examines whether a set of filters – for size, ROIC, free cash flow, and high valuations can shift the distribution of returns earned by an investor to the right of the return curve. Paper shows that a portfolio created on the basis of these filters (the expensive growth stock portfolio) consistently outperforms the broader market, while exhibiting lower downside volatility and lower maximum drawdown. Every portfolio created is held for a period of two years. In the study, conducted an empirical assessment of returns made from the expensive growth stock portfolio, from 2016 to 2020 - a total of 4 portfolios held for the full 2-year period, and 1 portfolio, created in 2020, held for 1 year - to assess the robustness of the strategy across different time periods and conditions in stock markets. Then paper compared the risk-return metrics – the Calmar, Sharpe and Sortino ratios - of the expensive growth stock portfolio and the benchmark index, and have shown that the expensive growth stock portfolio has better risk adjusted returns. Furthermore, our results pertaining to shift in the distribution of the returns earned by the investor, to the right of the return curve by investing in the expensive growth portfolio and test the statistical significance of the same. The results of the study states that systematic investing strategies in general and the expensive growth stock portfolio in particular, will aid the investor in beating broad market indices over the long run while having lesser downside volatility.