Trading Strategy Investigation

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Trading StrategyInvestigation

• BANKRUPTCY INTERNATIONAL
• Sumit Laddha
• John Maniatis
• Ozlem Tanik
• Robert Scott
• Melissa Dowsett

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Agenda

• Introduction
• Strategy
• Methodology
• Results
• Out of sample testing
• Conclusion

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Topic Hypothesis

• Examine a trading strategy based on using Capital
  Expenditure in the Utilities Industry
• High Capital Expenditure as a of Total PPE is
  a sign of future revenue and earnings increases
  in an industry with heavy capital expenditure
  requirements and low RD like Utilities

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Strategy Approach

• Future returns of companies with high capital
  expenditures will be higher than the index due to
  increased future revenue and earnings generated
  by the CapEx
• Approach is to build portfolios based on
  CapEx/Total PPE. Compare high / low portfolio
  performance to the SP 500 Utilities Index

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Variables

• CapEx/Total PPE
• Adjusts for the relative size of the company and
  shows the relative size of the expenditure
• Returns
• If the market responds to CapEx itself then we
  should see a good correlation with the shortest
  lag of returns
• CapEx is reported quarterly after the quarter
  when the investment is made, so the minimum is a
  lag 2 return

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Variables

• Returns (continued)
• If the market responds to the resulting increase
  in earnings/revenues, there will be a correlation
  with lag 3 or lag 4 returns
• CapEx may have an impact longer than one quarter,
  so we also looked at 1 year returns

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Data Selection

• The index selected was the SP500 Utilities Index
• Reasonable number of companies (approximately
  30-35)
• Industry where CapEx is a sign of growth in
  operating capacity
• Mature industry

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Time Frame

• Time frame selected was quarterly samples for
• In sample 1980-1995
• Out of sample 1996-2000

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Data Collection

• Required CapEx and PPE as well as Price
  information
• Issues
• Missing all data on 4 companies (Columbia Gas,
  Ensearch,
• Cant get future returns on a company that leaves
  the index because it has been acquired (due to
  lagging and the use of 1 year returns this
  impacted on portfolio selection for up to eight
  quarters before the company actually left the
  index)

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Evaluation of Variables-1Y
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Evaluation of Variables-1Q
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Results-1Q Capex
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Results-1Y Capex
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Out of Sample Testing
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Conclusion

• Our hypothesis is not supported by our analysis
• We observe a consistent reverse relationship
  between Capex and price.

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Conclusion-Possible reasons

• High capex gtdecrease in cash flows
• Effects of capex on profitability seen in longer
  time horizons
• Capex includes replacement cost (to overcome,
  compare with depreciation)