Trading Strategy
Investigation
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Sumit Laddha
John Maniatis
Ozlem Tanik
Robert Scott
Melissa Dowsett
Agenda
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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
PP&E is a sign of future revenue and
earnings increases in an industry with
heavy capital expenditure requirements
and low R&D like Utilities
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Strategy & Approach
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
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 PP&E. Compare high / low
portfolio performance to the S&P 500
Utilities Index
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Variables

CapEx/Total PP&E
• 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 S&P500
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
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Required CapEx and PP&E as well as Price
information
Issues:
• Missing all data on 4 companies (Columbia
Gas, Ensearch,
• Can’t 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
1 Year Capital Expenditure/Total PP&E
High
Low
1 Quarter 1 Quarter Return
Return Lag2
Lag2
Average Return
1.93%
9.83%
Average Excess
-1.566%
0.407%
Percent Above Index
37.50%
50.00%
High
Low
1 Quarter Return 1 Quarter Return
Lag3
Lag3
Average Return
4.02%
9.23%
Average Excess Return
-1.04%
0.26%
Percent Above Index
42.19%
53.13%
High
Low
1 Quarter Return 1 Quarter Return
Lag4
Lag4
Average Return
5.25%
8.40%
Average Excess Return
-0.81%
0.02%
Percent Above Index
42.19%
51.56%
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High
Low
2 Quarter Return 2 Quarter
Index
Lag2
Return Lag2
8.20%
3.16%
9.21%
-2.550%
0.479%
28.13%
53.13%
High
Low
2 Quarter Return 2 Quarter
Index
Lag3
Return Lag3
8.19%
4.12%
8.75%
-2.08%
0.24%
35.94%
48.44%
High
Low
2 Quarter Return 2 Quarter
Index
Lag4
Return Lag4
8.33%
5.20%
8.39%
-1.52%
0.08%
35.94%
51.56%
High
Low
1 Yr# Return 1 Yr# Return
Index
Lag 2
Lag 2
8.26%
4.09%
8.61%
-4.157%
0.364%
29.69%
51.56%
High
Low
1 Yr# Return 1 Yr# Return
Index
Lag 3
Lag3
8.28%
5.44%
8.17%
-2.95%
-0.23%
35.94%
48.44%
High
Low
1 Yr# Return 1 Yr# Return
Index
Lag 4
Lag4
8.24%
6.03%
7.51%
-2.61%
-1.13%
40.63%
48.44%
Index
8.25%
Index
8.40%
Index
8.65%
Results-1Q Capex
High & Low Portfolio vs. Index Returns
for 1Q Cap Ex/Total PP&E
10.000%
9.000%
8.000%
Annualized Returns
7.000%
6.000%
High Portfolio
5.000%
Low Portfolio
Index
4.000%
3.000%
2.000%
1.000%
0.000%
1Q Lag2
Portfolio
Return - High
2Q Lag2
Portfolio
Return - High
1 Yr# Lag 2
Portfolio
Return - High
1Q Lag3
Portfolio return
- High
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1Q Lag4
1 Yr# Lag 3
2Q Lag3
Portfolio return Portfolio return
Portfolio
- High
- High
Return - High
2Q Lag4
Portfolio
Return - High
1 Yr# Lag 4
Portfolio
Return - High
Results-1Y Capex
High & Low Portfolio Returns vs. Index
for 1Yr Cap Ex/Total PP&E
12.00%
10.00%
Annualized Returns
8.00%
High Portfolio
6.00%
Low Portfolio
Index
4.00%
2.00%
0.00%
1 Quarter Return 2 Quarter Return 1 Yr# Return Lag 1 Quarter Return 2 Quarter Return 1 Yr# Return Lag 1 Quarter Return 2 Quarter Return 1 Yr# Return Lag
4
Lag4
Lag4
3
Lag3
Lag3
2
Lag2
Lag2
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Out of Sample Testing
Out of Sample
0.00%
1.00%
2.00%
nruteR tnecreP
3.00%
4.00%
Index
Low Portfolio
High Portfolio
5.00%
6.00%
7.00%
8.00%
9.00%
Out of Sample Results
Out of sample
High Portfolio Low Portfolio Index
Average Return
6.05%
7.85%
3.64%
Average Excess Return
2.41%
4.20%
% Above Index
52.9%
70.6%
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Conclusion
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
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


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High capex =>decrease in cash flows
Effects of capex on profitability seen in
longer time horizons
Capex includes replacement cost (to
overcome, compare with depreciation)
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