A Study on the Performance of Value Stocks in the U.S. Stock Market

The objective of this paper is to construct an investment strategy based on the combination of return of capital (ROC) and earning yield ratio. The formula seeks out good businesses when they are available at bargain prices. That is to buy above-average companies at below-average prices automatic. The advantage with this method is that it is not a very difficult method and not complex than what it appears to be, particularly for ordinary investors. The return of capital and earning yield were employed in this study to examine a stock’s performance comparing to the performance of S&P500 as the market index. We used all stocks in Portfolio123 which are supplied by Compustat, Standard & Poors, CapitalQ, and Reuters for the period of January 2, 1999 to December 31, 2015. Its method looks for companies that have the best combination of ROC and earning yield. The overall results show that the companies with the higher ratio outperform the companies with lower ratio. These results are strong in the up market. It can be argued that the companies with a high ratio are likely to move toward their fundamental value and generate high excess return because its stock prices are now undervalued. The implications of the study are: (a) the combination of ROC and earning yield ratio may be a good indicator of the underpriced security; (b) This ratio is a more effective method, compared to earnings to price (E/P) or book-to-market equity (B/M) ratios. By using the combination of ROC and earning yield, the formula help buy those companies that provide the best combination of being cheap and good.