Use data from Market Insight (www.mhhe.com/edumarketinsight) to rank 10 firms of your choice, based on either the price-earnings ratio or the market capitalization (size). To find the data, enter a stock symbol and then look at the company's Financial Highlights in the Compustat Reports section. Divide the firms into five groups (quintiles) based on their ranking for the criterion that you choose. Next, find the one-year return for each firm by looking in the Company Profile in the Compustat Report section. Can you confirm or reject the P/E effect or the small-firm effect cited in this chapter? Now look at another criterion of your choice from the firms' Financial Highlights report. Can you uncover a new anomaly? Note: For your tests to be valid, they should be based on criteria observed at the beginning of the period. Why?
Use the price history supplied in the Excel Analytics section of Market Insight (www.mhhe.com/edumarketinsight) to calculate the beta of each of the firms in the previous problem. Use this beta, the T-bill rate (www.federalreserve.gov/releases/h15/data.htm has data on T-bill rates), and the return on the S&P 500 to calculate the risk-adjusted abnormal return of each stock group. Does any anomaly uncovered in the previous problem persist after controlling for risk?
Now form stock groups that use more than one criterion simultaneously. For example, form a portfolio of stocks that are both in the lowest quintile of price-earnings ratios and in the lowest quintile of capitalization. Does selecting stocks based on more than one characteristic improve your ability to devise portfolios with abnormal returns?
Select 10 firms from Market Insight (www.mhhe.com/edumarketinsight). Choose five that you are very familiar with and five whose names you don't recognize. (Hint: First click on the "Company" tab and then click on the "Population" button. This will bring up a list of all the firms that have data available on Market Insight.) Record the companies' stock symbols. Now go to the firm's Wall Street Consensus Report in the S&P Stock Reports section and answer the following questions:
How many analysts follow this stock? You can tell by looking at the Total Number of Ratings.
What is their consensus opinion?
What is the 12-month target price for the stock?
How has the number of analysts following the stock changed over the past two years?
Do the analysts expect this stock to overperform or underperform relative to the S&P Index over the next few months?
Repeat the process for the other nine firms. Would you classify any of the 10 firms you chose as a "neglected firm"?
