Cross-sectional performance of cyclically-adjusted enterprise multiples

Abstract

Value anomaly is one of the most studied topics of finance. Yet, enterprise multiples have been rarely used to study the value anomaly despite their prevalence in acquisition valuation. Further, cyclically-adjusted valuation multiples suffer from the same lack of attention, albeit their origins trace back to Benjamin Graham in the late 1930.

In this study, I fill the void and examine the value anomaly in U.S. stock market for the period 1984-2014 with cyclically-adjusted enterprise multiples. I form decile portfolios by sorting the investment universe upon EBIT/EV ratio and its cyclically-adjusted versions. The portfolios are rebalanced within three holding periods: 1-year, 2-years and 3-years. Subsequently, I examine the portfolios returns against risk.

EBIT/EV (and its cyclically-adjusted versions) based decile portfolios confirm the existence of value premium. However, I do not find that the cyclically-adjusted multiples produce greater value premiums than the conventional EBIT/EV ratio. The cyclically-adjusted ratios are able to find the best returning portfolios of the study when the holding period is extended to two years. In risk-adjusted terms, the other top decile portfolios are superior to value portfolios across all the ratios.