An Efficiency-Based Approach to Stock Selection
47 Pages Posted: 5 Jul 2015
Date Written: April 3, 2014
This study investigates the relationship between operational efficiency and stock performance. The analysis is conducted by building an efficiency-based stock selection strategy and assessing its performance over different investment horizons in a contextual and empirical setting provided by the U.S. Information Technology sector. By means of data envelopment analysis (DEA), operational efficiency is quantified into an efficiency score representing a consolidated measure of financial ratios. Based on the rankings of the estimated efficiency scores, various portfolios are formed and their performance is evaluated relative to appropriate market indices and the strategic benchmarks. Our empirical findings demonstrate that there is a significant and positive relationship between operational efficiency and stock performance, and establish that operational efficiency has significant explanatory power in describing the cross-sectional variations of stock returns. This study further presents an economic argument that posits operational efficiency as a systematic risk factor and the most likely source of excess returns of investing in efficient firms.
Keywords: Data Envelopment Analysis, Stock Selection, Operational Efficiency, Fundamental Analysis, Relative Value Analysis
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