The previous article presented the categorization of the 303 BSE 500 listed stocks into 220 growth, 45 value, and 16 income stocks. This article compares the annual average returns against the market returns for the time period 1st April 2000 to 31st March 2020 into 5 different groups:
- April 1, 2000 – March 31, 2005
- April 1, 2005 – March 31, 2010
- April 1, 2010 – March 31, 2015
- April 1, 2015 – March 31, 2020
- April 1, 2000 – March 31, 2020
The comparison helps identify stocks that are performing better than the market average. This makes it easier for investors to select the best stocks to invest in.
Understanding annual average returns and market returns
Annual average returns state the mathematical average of returns for the desired stocks series earned annually over a period of time. It represents the simple average of the daily stock prices. Therefore, the annual average return tells an investor what the performance of the stock has been in the past.
Wherein return for each of the stock is computed as:
Herein, daily dividend is exempted from return due to the absence of data.
On the other hand, market returns represent the market portfolio including all the assets with the value-based weighted portfolio. In simpler terms, annual average returns define the annual return of a particular stock while the market returns is a weighted sum of all stocks traded in the financial market.
Stocks yielding a return higher than the market return tend to put investors in the top position along with giving them the advantage of earning more profit. There are three categories of stocks:
- income, and
- value stocks.
Investors make use of quantitative analysis to compare annual average returns with the market returns (Shah, Isah, & Zulkernine, 2019). This comparison not only provides information about the nature of stocks but also supports investors with more detailed information regarding the desired benefit from performance analysis.
Comparison of annual average returns and market returns from 1st April 2000 to 31st March 2005
For the period 1st April 2000 to 31st March 2005, the comparison between the annual average returns and the market returns was done to examine the performance of stocks. The results are represented in table 1 below. Growth stocks have a major potential to earn compared to other stocks. These annual average returns satisfy the property of growth stocks yielded high mean value i.e. 0.280 compared to the mean value of market return as 0.163. However, in the presence of high variability in the market, the standard deviation and variance level are also high i.e. 0.607 and 0.368 against market return value of 0.520 and 0.270.
Moreover, the minimum level of return is -0.316 compared to the market minimum return of -0.297. Skewness value for both the returns is above 0.5 and less than 1, representing a moderately positive skewed dataset. However, there is slightly high skewness in the market returns i.e. 0.878 > 0.585 representing more asymmetry in the market returns. Kurtosis value further shows that with the market return value 2.468, which is close to 3 but average returns value is 2.132. Therefore, there are more extreme values in the average returns. Thus, due to dynamism in the growth stock market, there is more variation in the returns earned by the investors for the period 1st April 2000 to 31st March 2005.
Income stocks provide a steady source of income and dodge the volatility of the market. Table 2 below depicts that mean value of the average return is greater than market return (0.253 > 0.163). Compared to the growth stock, the mean average return is less. However, the standard deviation and the variability due to high volatility in the market is high i.e. 0.773 and 0.597 against 0.520 and 0.270. Minimum level of the income stocks average returns for the period is less than the growth stocks i.e. -0.453 but the maximum level is high i.e. 1.427 thus covering the high variability of market.
Skewness value for the stocks is between 0.5 and 1, representing moderate positive skewness. However, the level asymmetry present in the income stocks is greater than the growth stocks i.e. 0.703. Kurtosis level further shows that the value of the average return is 1.959 which is even less than the growth stocks. Thus, there are more extreme values present in the stocks. Hence, for the period 1st April 2000 to 31st March 2004, there has been high variability in the returns due to volatility with the existence of more extreme values compared to the growth stocks.
Value stocks are issued by the undervalued companies, therefore have fluctuating returns with less stability. Table 3 below represents the analysis of value stocks. The mean value of the value stocks average return shows a higher value of 0.462. Furthermore, the existence of the highest standard deviation and variance values compared to growth and income stocks i.e. 0.782 and 0.612 depicts the undervalued nature of stocks which led to less stability in the market. The minimum and maximum value of the stocks is highest i.e. -0.174 and 1.719 depicting the probability of having growth in the future.
The skewness value of the stock is also between 0.5 and 1 representing the moderately positive skewness, however, the level is high compared to growth and income stocks thus showing the presence of high asymmetry in the returns. Kurtosis value of 2.318 is high compared to other stocks by supporting the presence of less extreme values. Hence, value stocks for the period 1st April 2000 to 31st March 2005 depicts that due to the undervaluation of stocks and less stability, there has been an opportunity of gaining albeit with the presence of high variability.
Opportunity for higher profits in value stocks
Growth stocks though are considered as the source of higher profits for investors (Cussen, 2019) but for the period 1st April 2000 to 31st March 2005, value stocks showed better performance. With the presence of higher annual average return in comparison to the market return and the better-earning possibility compared to the growth and income stocks, value stocks provided better returns to investors. For risk-averse investors due to the presence of high volatility, the investment is not appropriate. Since rational investors intend to reduce the risk of loss, they would opt for growth stocks with comparatively low risk. However, the presence of uncertainty in the financial market changes the investment opportunity for rational investors.
- Cussen, M. P. (2019). Income, Value, and Growth Stocks. Retrieved April 3, 2020, from https://www.investopedia.com/articles/investing/080113/income-value-and-growth-stocks.asp
- Hargrave, M. (2019). Average Return Definition. Investopedia. https://www.investopedia.com/terms/a/averagereturn.asp
- Shah, D., Isah, H., & Zulkernine, F. (2019). Stock market analysis: A review and taxonomy of prediction techniques. International Journal of Financial Studies, 7(2). https://doi.org/10.3390/ijfs7020026
- Tracy, P. (2020). Average Annual Return (AAR).
- An overview of the annual average returns and market returns (2000-2005) - October 22, 2020
- Introduction to the Autoregressive Integrated Moving Average (ARIMA) model - September 29, 2020
- Risk tolerance by stocks categorization using ratio analysis - September 10, 2020