Outperforming Stock Indices Using Proxies for Risk and Returns

This study builds on earlier findings that factors such as size, value and momentum are responsible for portfolio returns. In addition it has been shown that capital expenditures by the firm are predictors of future returns. This study examines the impact of capital expenditures and incorporates Altman’s Zeta score, a measure of bankruptcy as a proxy for risk based on firm specific financial statements. The study finds that excess return effects are present and statistically significant in small- cap and mid- cap stocks. The findings show that absolute and risk–adjusted returns are significantly improved by using capital expenditure and Z-Scores as discriminants for security selection. The findings conclude that investors using public information, can systematically outperform stock indices using a multiple factor model that includes capital expenditures and Altman’s Z-score as proxies for expected returns and risk.

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