Contrarian investment strategies on the Swedish stock market

Henriette Wennicke

Student thesis: Master thesis


For decades academics and investment professionals have argued that value strategies outperform growth strategies. Value strategies are identified as strategies where stocks with low prices relative to earnings, cash earnings, book value and other measures of fundamental value are bought, to be able to generate abnormal returns. In general, there is almost universal agreement among researchers on the existence of the value premium in stock returns. The issue of underlying causes for the value premium is far more contentious. The objective of this thesis is to examine whether the value-phenomenon is present on the Swedish stock market, which is the largest market in the Nordic region. Additionally the thesis explores whether value strategies yield higher returns due to increased risk or irrational behavior of market participants. The value-phenomenon is indeed present in the Swedish stock market. Accounting and stock market data have been collected for stocks in the OMXS30 index since 1987 and onwards. Value and growth portfolios have been formed based on different sorting variables; Price-to-earnings (P/E), Price-to-cash earnings (P/C), Price-to-book (P/B) and Asset growth (ASSETG). The test and analysis of the four different strategies with either one-, two- or three-year holding periods show that the value strategy in general outperforms the growth strategy on the Swedish stock market. Thus, most of the strategies produce returns that are insignificant, which might however be a consequence of the small sample size. The value premium for the one-year value-weighted strategy is between -1.082% and 7.233%. When the stocks within the portfolios are equally-weighted, the premiums become even stronger and more significant, which might be due to small-cap effects. The same pattern is found when the holding periods were extended to two and three years. The risk based explanation is analyzed, but it does not seem to explain the value premium. The traditional systematic risk measure beta is on average lower for value portfolios than for growth portfolios, which totally contradicts the traditional finance theory. Additionally the value strategy does not perform worse in bad states of the economy, which otherwise could have indicated that the value stocks had increased downside risk. The irrational arguments seem to fit the existence of the value premium better. Investors are subject to several kinds of judgment biases, which originate from limited cognitive capacity. Therefore different types of heuristics are used that can limit the investors’ ability to make rational decisions. Incorrect usage of heuristics can encourage investors to extrapolate past performance too far into the future. When performing a simple extrapolation test on the Swedish stock market it is found that the net profit growth ahead of portfolio formation is slightly negative for the value portfolio, whereas net profit after formation is slightly positive. The picture is the opposite for the growth portfolio. The results indicate that markets undervalue value stocks and overvalue growth stocks, which lead to a positive performance of value stocks when the market participants realize that their view of growth stocks have been too optimistic and their view of value stocks too pessimistic.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
Publication date2008