The combination of Momentum and Price to Book investment approach outperformed the market by more than 1100% in our 12-year retrospective in Europe from June 1999 to June 2011.

It’s time for an upgrade.

The Original 2012 Backtest Performance

To refresh your memory, here are the outcomes of the June 1999 to June 2011 backtest:

Source: What Works on European Markets

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Momentum + Price to Book Investment Strategy Update

We have refined the backtest using the Quant Investing stock screen back test function. It only encompasses data going back to December 2015, resulting in a 4.5-year gap between the two backtests.

We believe that evaluating it over the seven years from 2016 to 2022 will still offer valuable insights into its efficacy.

What We Examined

Similar to the original backtest, we applied the strategy to all companies in the Eurozone countries (using Euro as currency) with a trading volume exceeding €100,000 over the past 30 days and a market value surpassing €100 million.

Initial Selection

From this pool, we initially selected the top 20% of companies exhibiting the highest stock price surge over the past six months – denoting the most robust six-month momentum.

Subsequent Selection

We arranged this cluster of companies based on price to book from lowest to highest and then evenly invested in the 50 companies with the lowest price to book ratio.

In essence, this is the gist of the screening process:

• All companies in the Eurozone
• With a 30-day average trading value exceeding €100,000
• Featuring a market value surpassing €100 million
• With financial statements updated within the last six months
• Select the top 20% of companies with the strongest six-month momentum
• Organize this list based on price to book from lowest to highest
• Invest in the 50 companies with the lowest price to book value
• Evenly weighted portfolio
• Rebalanced annually

Performance Over Seven Years +44%

This is the performance of the strategy over the seven-year span from December 2015 to December 2022.

Dividends not included

Source: Quant Investing Screener back test

Dividends not included

Source: Quant Investing Screener back test

Outperforming the Market Comfortably

As evident, the strategy comfortably outperformed the European STOXX 600 index by 27% (43.9%-16.8%) over seven years.

However, it was not a steady journey! The strategy exhibited a higher standard deviation (larger fluctuations) almost double that of the market, 23.8% in contrast to 13.2% of the index.

It also underperformed the market only twice, in 2018 and 2022 over the seven-year period.

As anticipated, it didn’t surpass the market by as wide a margin as it did in the 12-year period from June 1999 to June 2011 when it exceeded the market by 1127.0% (1157.5% – 30.54%).

This is Entirely Normal

This is a common occurrence with strategies that have experienced significant success.

The heightened returns correspond to all companies aligning with the strategy becoming pricey, and no new promising prospects fulfilling the strategy’s criteria emerging.

Or the market conditions attributing to these undervalued companies changed, leading to a decrease or cessation of the outperformance.

Consider, for instance, oil companies subject to undervaluation based on the price to book metric due to the dip in oil prices. Once these companies rebounded, the momentum filter and subsequent low price to book search would have identified them. Nevertheless, as they became expensive, that trend vanished, and the subsequent set of companies adhering to the strategy didn’t perform as impressively.

The Pitfalls of Backtesting – Data Mining

This also underscores the pitfalls of backtesting.

• You identify a strategy that excelled in a backtest.
• You start implementing it in your portfolio.
• The performance disappoints.

What we did in the original backtest was effectively data mining. We evaluated 196 strategies and subsequently established that Momentum and Price to Book was the top-performing strategy.

However, in June 1999, there was no way for you or us to anticipate that this strategy would emerge as the most successful.

Identifying Your Strategy and Staying True to It

The best course of action is to identify a strategy with a sound long-term track record that resonates with your temperament and adhering to it through thick and thin.

Does this guarantee that you will consistently surpass the market?

Certainly not, every strategy experiences periods of underperformance. Hence, it’s crucial to have unwavering confidence in its historical performance to avoid abandoning it at the least opportune moment.

Most likely, you might hastily shift to another strategy that initially excelled, only for it to start lagging behind the market. And that represents your greatest risk as a long-term investor.

To start identifying Momentum and LOW Price to Book companies for your portfolio NOW! – Click here