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Peer Pressure: Industry Group Impacts on Stock Valuation Precision and Contrarian Strategy Performance

28 Pages Posted: 18 Jul 2009 Last revised: 27 Feb 2012

Turan G. Bali

Georgetown University - Robert Emmett McDonough School of Business

K. Ozgur Demirtas

Sabanci University

Armen Hovakimian

Baruch College - Zicklin School of Business

John J. Merrick Jr.

College of William and Mary - Mason School of Business

Date Written: 2006

Abstract

Investment bankers focus on narrow, industry-based peer groups for individual stock valuation. And some market-neutral equity hedge fund managers restrict their portfolios to be sector-neutral as well. Yet, academic research into contrarian strategy investment performance has typically invoked full universe valuation and ignored industry effects. Here, we find in favor of the bankers’ and hedge fund managers’ approach. Industry effects matter. Narrow industry-based peer groups improve stock valuation precision for three key valuation ratios. While our analysis of the dynamics of these ratios indicates substantial inertia in relative value rankings, we find that average returns to industry-based contrarian portfolio strategies are positive, statistically significant, and persistent. And over a sample that extends through the “new economy/old economy” and boom/bust period of the late 1990s, contrarian strategies were particularly profitable for NASDAQ-listed stocks. Most importantly, using our full sample of stocks, we show that an industry-neutral strategy is far superior to an industry-exposed, full universe strategy in Sharpe ratio terms over every horizon for each valuation ratio. Thus, contrarian strategy portfolio performance is significantly improved in risk-adjusted terms when implemented in its industry-neutral hedging form.

Suggested Citation

Bali, Turan G. and Demirtas, K. Ozgur and Hovakimian, Armen and Merrick, John J., Peer Pressure: Industry Group Impacts on Stock Valuation Precision and Contrarian Strategy Performance (2006). Journal of Portfolio Management, Vol. 32, No. 3, pp. 80-92, 2006. Available at SSRN: https://ssrn.com/abstract=1434410

Turan Bali

Georgetown University - Robert Emmett McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
(202) 687-4031 (Fax)

HOME PAGE: http://msbonline.georgetown.edu/faculty-research/msf-faculty/turan-bali

K. Ozgur Demirtas (Contact Author)

Sabanci University ( email )

Graduate School of Management
Orhanli Tuzla
İstanbul, 34956
Turkey
(+90) 216-483-9985 (Phone)
(+90) 216-483-9699 (Fax)

Armen Hovakimian

Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-225
New York, NY 10010
United States
646-312-3490 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/ahovakimian/

John Merrick

College of William and Mary - Mason School of Business ( email )

P.O. Box 8795
Williamsburg, VA 23187-8795
United States
757-221-2721 (Phone)
757-221-2937 (Fax)

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