A Study of Value Investing : Empirical Analysis of Shari’ah Compliants
Diana Hashim Syarif1, Jeudi Agustina T.P. Sianturi2, Sugeng Wahyudi3
1
Ph. D Program of Finance at Diponegoro University, Semarang
([email protected])
2
Ph. D Program of Finance at Diponegoro University, Semarang
([email protected])
ABSTRACT
Buying high quality assets without paying premium prices is just as much value investing as buying average quality
assets at discount prices. Strategies that exploit the quality dimension of value can be profitable on their own, and
accounting for both dimensions of value yields dramatic performance improvements over traditional value strategies.
Attention to quality, helps traditional value investors distinguish bargain stocks (i.e., those that are undervalued) from
value traps (i.e., those that are cheap for good reasons), and generates significant abnormal returns. In this study, an
investment strategies based on Grantham’s quality criteria on investing namely, “high return, stable return, and low
debt”, is applied to analyze the performance of shari’ah complaints, and compared to F-score investment criteria
(Piotroski, 2000) by conducting t-tests on the cumulative returns. The finding indicated that F-score outperformed
shari’ah portfolio.
Keywords: Value Investing, Asset Pricing, Shari’ah Compliants
1. Introduction
Prospect theory (Kahneman and Tversky,
1979) gives a view that investors tend to respond
differently to an information, particularly relating to
the advantages and disadvantages. Individuals are more
negatively impacted by losses than they are positively
impacted by a gain of similar magnitude. This is
because the slope of the utility function in the loss
domain is steeper than in the gain domain. Besides, the
prospect theory also explains that a person tends to
take a bigger risk to avoid losses than the risk to
benefit, in the sense, if one is confronted with a profit,
the person will tend to be risk averse, and being risk
taker when confronted with a loss. By conducting
several studies using surveys and interviews, they
found that people under weigh outcomes that are
merely probable in comparison with outcomes that are
obtained with certainty. However, between a sure loss
and a possible loss, people over weigh the prospect of a
possible loss. In other words, given the same options
framed differently, people are generally risk averse in
the positive domain and risk seeking in the negative
domain (Kahneman and Tversky, 1979, 1981, 1984).
Indeed, people may be better described as loss averse
rather than risk averse. With such characteristic,
prospect theory moreover suggests that investors are
likely to choose the skewed portfolio over the efficient
portfolio because the gain in utility for doing better in,
especially in falling markets, is larger than the loss in
utility for underperforming in rising markets.
The continued trend toward risk-averse
investment is bringing Islamic investment into the
spotlight. Though the growth of Islamic finance has
been steadily intensifying for more than two decades,
but interest in the story of its success accelerated just
for a few years as the more conventional financial
industries faltered. The sector continues to garner
attention because of its unique philosophy which
significantly differs from traditional investment
approaches, particularly as it relates to risk. Its tenet-lower leverage--make it an attractive investment option
in any market environment and can be branded as
“quality investing”. Prior study showed, since 1965 the
least levered firms (lowest 25%) have had average
return on equity 5% higher than the most levered firms
(highest 25%)(Joyce and Mayer, 2012), and it can be
claimed that leverage is the ultimate source of
investment return.
Financial theory posits that return is a major
factor in investment decisions. Numerous studies
proved that the shari’ah-compliant investments have
better performance than (outperformed) their
conventional counterparts (Milly and Sultan, 2012;
Beer et. al., 2011; Alam and Rajjaque, 2010; Akhtar et.
al., 2011; Al-Zoubi & Maghyereh, 2007; Hassan et. al.,
2005; Hussein, 2004; Hussein & Omran, 2005;
Hussein, 2007; Sadeghi, 2008; Yusof and Abdul Majid,
2007; Atta, 2000). Meanwhile from the perspective of
risk, prohibition investing in risky financial assets
The 2017 International Conference on Management Sciences ( ICoMS 2017) March 22, UMY, Indonesia
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(riba) and speculative products reduce variance in
shar’iah-compliant investments (Sing and Loh, 2014)
and lower standard deviation (Abdullah et. al., 2007;
Lean and Parsva, 2012) than conventional. This finding
was supported by Kassab and Morocco (2013) where
they revealed that Islamic index is less volatile with a
lower standard deviation than the conventional index.
In Islamic economy, money is only a mean of
exchange: it cannot be used as an asset to generate
profit. In another similar case, it cannot be left
unproductive, since hoarding is not allowed under
Shari’ah (Forte and Miglietta, 2011; Saitia et. al.,
2014). This resulted in or created shari’ah products less
risky or lower risk (Saitia et. al., 2014). The advocates
of Islamic investment argue that the Islamic stock
indices such as, ethical and ratio screening, exclusion
of financial sectors, exclusion of highly leverage firms,
the limit of interest-based leverage, and finally,
exclusion of using complex and intensive structured
financial products, derivatives, and other toxic assets,
are argued to be more resilient to a financial crisis
compared to a conventional stock index (Charles, Pop
& Darne, 2011; Sukmana and Kholid, 2012; Milly and
Sultan, 2012).
The concept of “quality or value investing”
was first proposed by Benjamin Graham, a smart
investor who was considered by many as the “Father of
Value Investing”. Graham emphasizes the importance
of investing with a “margin of safety,” which
represents the difference between a company’s stock
price and the value of the underlying business of that
company, often called its intrinsic value. Generally,
value investors are not interested in stocks that trade at
a slight discount to their underlying value. Rather, they
are looking for solid companies whose stock prices are
selling at “pennies on the dollar” compared with the
intrinsic values of the businesses they represent. Value
investors believe that a large margin of safety provides
greater return potential as well as a greater degree of
protection over the long term. Graham believed that
purchasing stocks at sizable discounts would protect
investors against permanent loss and allow them to
dispense with the need for making accurate estimates
of the future. He also believed that buying undervalued
firms, which means buying high quality firms cheaply.
Since Graham proposal, some leading
proponents include Jeremy Grantham have encouraged
a generation of value investors to pay attention to
quality. His philosophy of value investing emphasizes
purchasing stocks of companies as those that meet the
criteria of low leverage, high profitability, and low
earnings volatility, and suggests that stocks of firms
with these characteristics “have always won over
longer holding periods.” These criteria are consistent
with shari’ah compliance and also the most quality
metric commonly used. Based on the general principles
of value investing, quality characteristics can be
grouped into three main categories (Norges Bank
Investment Management, 2015): (1) profitability, (2)
safety, and (3) quality of earnings.
The first criterion was to fulfill Grantham
criterion that quality firms are often described as
profitable firms. Some authors have documented
profitability as factor which explain the cross-section
of stocks returns (Fama and French, 2014; Novy-Marx,
2013, Cooper et. al., 2008, Titman et. al., 2004).
Although the authors differ on characteristics that can
be used as a proxy for profitability, they present robust
evidence that there is a premium associated with this
factor. Profitability generally refers to a company’s
ability to generate earnings as compared to its
expenses. The second criterion are often described as
safe and stable companies. Excessive leverage may
jeopardise a company’s ability to service its debt and
ultimately lead to financial distress. Safety is typically
associated with a strong balance sheet, e.g. low
leverage. The third criterion refers to both earnings
persistence (stability) and “accounting” quality. Based
on these three information; therefore, the main
contribution of this paper is investigating the
performance of shari’ah stocks and comparing it with
the F-score method frequently used by many scholars
for value investing analysis (Cheng & Wang, 2014),
which was established by Piotroski (2000). This study
is important for one reason. Although Shariahcompliant is an area that has already attracted a great
deal of research interest, particularly the financial
performance of these funds well-documented, but
academic research on shari’ah compliant as “quality
investing” is rare. To the best of my knowledge, no
similar study on it has been conducted before.
2. Literature Review
One of the more popular methods investors
use to make money on the stock market is called value
investing. (Arnold 2008). The concept of value stocks
can be traced back as far as to 1934 and since then
investors have been searching for value stocks to invest
in (Graham & Dodd, 1934), meaning that an investor
should search the market and find stocks that are
undervalued and have the potential to generate a capital
gain, or promise high returns and are often rather cheap
to purchase. Typically, the earnings for companies who
have value stocks are depressed in the past and their
future is rather uncertain or the companies have
reached maturity and are presenting a stable
performance. (Chen and Zhang 1998). According to
Fama & French (1998), the rather high returns of a
value stock often arises since the market has
undervalues distressed stocks and when these pricing
errors later are corrected the value stocks yield high
returns.
Arnold (2009) mentioned that one strategy to
discover stocks that might be undervalued is to analyze
different accounting ratios. If this analysis is carried
out in the correct way it will lead to the investor ending
up with two different types of stocks, value stocks and
growth stocks. The difference in returns between value
and growth stocks has been called a value premium
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(Athanassakos, 2009). Growth stocks are stocks that
have high expectations on their future earnings, their
growth rate are high compared to market average and
they are expected to continuous raise further in the
future (Bourguignon & De Jong, 2003). Investors who
might be interested in buying this type of stocks are
referred to as growth investors. Growth stocks are
often a rather popular investment choice since the
companies who possess these stocks tend to create
innovative products with market opportunities
(Bourguignon & De Jong, 2003). Investors are then
hoping that the market value of these innovative firms
will rise rapidly leading to higher returns from the
growth stocks. (Bourguignon & De Jong). According
to Bauman & Miller (1997) an investment in growth
stock is especially popular and attractive during times
of strong economic growth. Further, they explain that a
stock can be characterized as a growth stock if the
stock has high earnings to price (P/E), price to book
(P/B) and/or price to cash flow (P/C).
To be compared to value stocks, evidence
seems to indicate that there is some truth to the claim
that value stocks do outperform growth stocks.
Numerous studies have investigated the difference
between value and growth investing strategies by using
factors such as P–E, P–B, and P–S ratios. Basu (1975)
was one of the earliest researchers to test low P/E
stocks in order to see whether they outperformed high
P/E stocks on the New York Stock Exchange between
the years 1956 to 1969. The results were that low P/E
stocks consistently outperformed high P/E stocks and
earned abnormal returns. In 1997, he continued to test
the low versus high P/E ratios on the New York Stock
Exchange between the years 1956 to 1971. This time
focusing on critics from market efficiency advocates
who argued that the reason value stocks seemed to
outperform growth stock was because they were much
riskier. Basu showed with his research that, even when
risk-adjusted, value stocks outperformed growth
stocks. Finally, he wrote another article (1983) on low
price to earnings ratio stocks or earnings yield as a
response to a lot of previous market efficiency research
claiming that a low price to earnings stocks would not
have a consisting superior return compared to other
stocks. He divided all the stocks on the New York
Stock Exchange during the period 1963 through 1979
into different portfolios depending on their P/E ratios.
He concluded that a portfolio of low price to earnings
ratio on average outperformed other portfolios tested.
Fama and French (1992) conducted research
on the New York stock exchange during the years 1963
to 1990 and showed that low price to book ratios had a
better performance than high price to book ratios. In
1998, they extended their study from not just including
the US market but this time they investigated if value
stocks are performing better than growth stock around
the world. They conducted their study on the time
period 1975-1995 and used the US and twelve major
EAFE (Europe, Australia, and the Far East) stock
markets as their sample. Data was collected and they
created portfolios of value and growth stock. In order
to determine if a stock was considered to be a value
stock or a growth stock they used accounting ratios
(B/M, E/P, C/P, and D/P). Stocks with high ratios were
said to be value stocks and stocks with low ratios were
considered to be growth stocks. After performing
various statistical tests Fama & French come up with
the conclusion that value stocks tend to have higher
returns than growth stocks in markets around the
world. This was the fact in twelve out of thirteen
markets. Value stocks performed 7.68% better than
growth stocks per year. They created a model that
showed that most in most of the countries the value
premium was due to a higher level of risk. By this
background, Zhang (2005, p. 67-95) was trying to find
out why value stocks are related to higher risk and
thereby earn higher returns than growth stocks
although growth stocks depend on future economic
conditions and actually should bear higher risk. They
tested this on the New York Stock Exchange and in
Japan, Hong Kong, Malaysia, Taiwan and Thailand.
Rational expectation and the neoclassical industry
equilibrium framework along with various economic
variables are used to analyze the relationship between
risk and expected return. Zhang concludes that costly
reversibility and countercyclical price are the reason
behind why value stocks are more risky than growth
stocks and especially during an economic distressed
situation. But, Lakonishok et. al. (1994) tested this on
U.S stocks and found that value stocks on the contrary
were less risky compared to growth stocks, and still
outperformed them. They examined P-E, P-B, and PCF ratios within 1963 to 1990 and revealed that
investing in value stocks outperformed investing in
growth stocks in many cases over their time period.
They found that one reason for this could be that future
growth rates of earnings and cash flows of growth
stocks relative to value stocks were much lower than
they were in the past. This means that future growth
rates of growth stocks has been overestimated. Further,
they concluded that value strategies did not appear to
be more risky than growth strategies. Gregory et. al.
(2003) agreed with this and saying that value stocks
outperformed growth stocks but wanted to test whether
this was due to a higher risk level for the value stocks.
They used valuation ratios such as P/E and P/CF to
distinguish the value and growth portfolios from each
other. During the time period from 1980 to 1998 they
tested all the stocks on the New York stock exchange.
Their findings suggested that value portfolios were not
riskier than the growth portfolios but still outperformed
the growth portfolio.
Bauman et. al. (1998) conducted a study
investigating if value stock-strategies outperformed
growth stock-strategies. They employed P-E ratio,
dividend rate, and expected-earning growth rate to
distinguish the growth and value stocks. The study was
done on the international market, Australia, Europe,
and East Asia. The results indicated that value stocks
generally outperformed growth stocks in all three
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regions. Consistent with this results but different in
style, Pätäri & Leivo (2009) conducted a study on
different value strategies on the Finnish market over
the years 1993-2008. Their sample of stocks was
divided into three different portfolios depending on six
different accounting variables, the ratios used were
E/P, EBITDA/EV, CF/P, D/P, B/P and S/P. The stocks
with the lowest ratios are placed in a portfolio
consisting of value stocks and the stock with highest
ratios are belonging to a portfolio of glamour (growth)
stocks. In order to risk adjust their stock returns Pätäri
& Leivo use several performance metrics such as the
Sharpe ratio, the adjusted Sharpe ratio, the Jensen
alpha, and 2-factor alpha. The results of the study are
in line with previous results from other researchers,
meaning that the portfolio of value stocks in most cases
outperforms the portfolio consisting of glamour stocks.
Along with Kilpiä, in 2009 Pätäri & Leivo conducted
another similar research on the Finnish market which
focused on how value and growth portfolios perform in
bull and bear markets. Their findings of this study
show that the portfolios with values stocks are less
affected by bear markets than other stocks on average
are.
Newer studies also seem to confirm the
previous finding, examples of being Fama and French
(2012) where the aim was to find a value premium of
value stocks. The study was done during the years
1989 to 2011 on four different regions, North America,
Europe, Asia Pacific and Japan. The returns from the
regions were calculated as averages from all the
countries stock returns added together. The results of
the study were that all the regions except Japan
displayed a value premium. Asness et al (2013)
expanded the research done by Fama and French
(2012) by testing if a value premium and momentum
existed from 1972 to 2011 and additionally also tested
other assets than stocks. They used a similar division of
regions as Fama and French and found again similarly
to Fama and French a consistent value premium. Value
premium
was
also
found
in
Thailand,
(Sareewiwatthana, 2011) in India (Deb, 2012) in New
Zealand (Truong, 2009) and finally Australia
(Gharghori, et. al., 2013)
Previous studies have demonstrated that value
investing is superior in many regions. This means that
if an investor is following the principle of value
investing it would in most cases be appropriate to look
for value stocks to invest in. However, the approaches
used by previous scholars have predominantly used
indicators such as price to earnings (P/E), price to book
(P/B), and/or price to cash flow (P/C) ratios in order to
evaluate if a stock actually can be considered to be a
value stocks. If a company has low ratios of price to
earnings (P/E), price to book (P/B) and/or price to cash
flow (P/C) they can be assumed to have value stocks
(Fama & French, 1998). According to Fama & French
(1998) the reason to why these multiples are most
commonly used is since they produce stable results in
returns. Unlike previous studies, this study does not use
the conventional indicators. Instead, it is using Jeremy
Grantham’s method to analyze whether shari’ah
compliant investments could be considered as value
stocks. According to Grantham, value stocks are those
that meet the criteria of low leverage, high profitability,
and low earning volatility. As mentioned above, these
three criteria are consistent with shari’ah compliance
and also the most quality indicators commonly used
(Norges Bank Investment Management, 2015).
3. Research Design
3.1 Shari’ah Portfolio
In this study, the shari’ah portfolio generally
is developed using three indicators: profitability,
leverage, and accrual. Therefore, the stock selection
involved selecting companies that met the following
three criteria and analyzing their profit performance:
Profitability: In this study, profitability is measured by
ROA, which indicate how well the company is
deploying its capital to generate returns. Only
companies that possessed positive ROA during 3 years
(2012-2014) fulfilled the criterion of profitability.
Leverage : Debt ratio is applied to measure leverage in
this study and only companies that have debt ratio
below and/or maximal 45% each year from 2012-2014
fulfilled this criterion.
Accrual: This refers to both earnings persistence
(stability) and “accounting” quality. A stable and
persistent stream of earnings can indicate that a
company has a competitive advantage, above-average
management and a dominant market position. Earnings
stability can be measured by the volatility of earnings
per share (EPS) or EPS growth, as well as by the
volatility of various profitability metrics such as ROE,
ROA and ROIC. But in this study, it is considered by
the following metrics:
Accrual =
Cashflow from operations - Net profit
(1)
Net profit
3.2 F-score
In this study, the F-score portfolio is developed
based on the F-score investment criteria proposed by
Piotroski (2000), which comprises two stages.
Stage 1: Identifying Excellent Companies
Company stocks were assessed and scored
using the F-score method. Four financial variables
were considered; the stocks that met the criterion
obtained 1 point. The F-score ranged from 0 to 9
points; stocks that obtained 7–9 points were in the
high-score group. The criterias are as follows:
Return on assets (ROA): If the ROA in the current year
is positive, the stock scores 1 point; if not, the stock
The 2017 International Conference on Management Sciences ( ICoMS 2017) March 22, UMY, Indonesia
10
scores 0 points. ROA = net profit after tax/average total
assets. Change in total return on assets (∆ROA): This
was calculated by subtracting the previous-year ROA
from the current ROA. When ∆ROA is 0 or higher, the
stock scores 1 point; if not, the stock scores 0 points.
Accrual: When accrual is negative, the stock scores 1
point; if not, the stock scores 0 points.
In this study, the datas of stocks and financial
ratios were collected from the database of Index Saham
Shari’ah Indonesia. The data period was between 2012
until 2014. The research sample consisted of listed
companies were selected based on the Grantham
criteria and F-score method.
4. Empirical Results
Change in debt ratio (∆LEVER): When the debt ratio
in the current period is lower than that in previous
period (i.e., when ∆LEVER is negative), the stock
scores 1 point; if not, the stock scores 0 points. Debt
ratio = total liabilities / total assets.
4.1 Descriptive Statistics
Stage 2: Identifying Favorable Stocks
The scores of the 4 criterias are totaled for
each stock; stocks that obtained 7-9 points are
categorized into the high-score group.
Table 2. Descriptive Statistics for F-score
No. of
Mean
Std.
Companies
Deviation
ROA
29
0.908046
0.290636
29
0.689655
0.465317
ROA
29
0.103448
0.306309
Debt Ratio
Accrual
29
0.747126
0.437179
3.3 Measurement of Stock Selection Performance
The stock selection performance of the
shari’ah portfolio (using Grantham criteria) is
compared with that of the F-score method, by
conducting t tests on the cumulative returns. The
purchase price (the closing price of the first month in
the first year) and the selling price (the closing price at
the end of each year) are used to calculate the
cumulative return for each year.
3.4 Data Period and Data Source
Shari’ah
F-Score
4.1.1 F-score and PDF portfolios
Table 2 shows the descriptive statistics for the
high-score group generated using the F-score method.
The mean values for the analyzed data were as follow:
ROA (0.908046%), ROA (0.689655), Debt Ratio
(0.103448), and Accrual (0.747126). In addition, the
mean values of ROA, ROA, and accrual greater than
the standard deviation, which means a good
representation of the overall sample. It is also can be
seen that indicator of changes in ROA and debt ratio all
increased between during 3 years (2012-2014).
Table 1. Number of Sample Companies
Criteria
Fullfilling the Criteria
(acquiring positive ROA & debt ratio below
and/or max 45%)
No. of Companies
50
0-3
4-6
7 - 9 Fulfilling the criteria
No. of Companies
5
70
29
29
Table 1 displays the sample companies that are
selected using the Grantham approach and F-score
method. Regarding the Grantham criteria for shari’ah
portfolio, a total of 50 companies fulfilled the criteria
(acquiring positive ROA and debt ratio below and/or
maximal 45%). From the F-score assessment, the
number of companies that acquired 0–3 points 4–6
points, and 7–9 points (high-score group) was 5, 70,
and 29 companies, respectively.
Meanwhile, table 3 displays the descriptive
statistics for the shari’ah portfolio selected using the
Grantham criteria. The minimal ROA was 0.040, and
the maximal value was 74.480, which were both
positive. The mean value of ROA was 11.158, and the
standard deviation was 8.363, indicating a substantial
difference in ROA among the various individual stocks
and also showed a good representation of the overall
sample. The mean value for debt ratio was 27.560%
with a maximum and minimum of 45.00% and 7.00%,
respectively. Observation for accrual during 3 years
(2012-2014) shows that the mean value of which was
215.7023.
Table 3. Descriptive Statistics for Shari’ah Portfolio
No. of
Min.
Max.
Mean
Std. Dev.
Companies
ROA
50
0.040
74.480
11.158
8.363
Debt Ratio
50
7.000
45.000
27.560
9.345
Accrual
50
3.02
9577.12
215.7023 906.3961966
The 2017 International Conference on Management Sciences ( ICoMS 2017) March 22, UMY, Indonesia
11
Table 4 display the comparison of average cumulative
returns between shari’ah portfolio and F-score
portfolio.
various investment strategies based on the finding of
this study to propose an optimal investment.
Reference
Table 4. Average Cumulative Returns
Year
Shari’ah Portfolio
F-Score
2012
16.35
53.51
2013
4.97
15.76
2014
7.46
27.86
The results showed that the cumulative return on Fscore was superior to that on the Shari’ah Portfolio
during 3 years (2012-2014).
This study used financial indicators to analyze
the profitability, solvency, and earning stability of the
companies selected by using the F-score methods and
Grantham criteria for shari’ah portfolio. T tests were
then conducted to examine the differences between the
shari’ah and and F-score portfolios. The returns were
observed during 3 years (2012-2014). Table 5 presents
descriptive statistics for cumulative returns between the
shari’ah and F-score portfolios. The finding showed
that F-score outperformed (better than) shari’ah
portfolio.
Table 5. Descriptive Statistics for Cumulative Returns
of Shari’ah and F-Score Portfolios
Year
Portfolio
Mean
Std. Dev.
t-test
2012
Shari’ah
1237.49
6974.73
1.267
F-Score
55.09
126.34
2.348
2013
Shari’ah
-444.45
3658.18
-0.868
F-Score
15.76
85.10
0.997
2014
Shari’ah
566.80
3521.19
1.150
F-Score
27.86
45.41
3.304
5. Conclusion
This study developed Grantham criteria for
analyzing the performance of shari’ah stocks, which is
based on profit (ROA), solvability (debt ratio), and
earning stability (accrual). The performance (return) of
shari’ah portfolio was examined over a period of 3
years (2012-2014). Compared to F-score method, the
results revealed that the 3-year cumulative returns on
the stocks selected using Grantham criteria for shari’ah
portfolio underperformed the stocks selected using the
F-score method.
6. Limitations
Value investing emphasizes long-term
investment performance. Therefore, it should be
analyzed by using a long period of time to avoid an
increase in transaction costs and a reduction in profits.
In this study, stocks were selected using three
combination of indicators, and returns were examined
in period of 3 years. Future studies can apply long-term
period of time for shari’ah stocks and compare it with
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