Multiples and future returns : an investigation of pricing multiples’ ability to predict abnormal returns on the Oslo Stock Exchange

Abstract

The purpose of this master thesis is to investigate the relationship between pricing multiples and future abnormal returns. An important part of the thesis is to find out whether a strategy using multiples as a selection tool can yield positive abnormal returns. We analyse all available companies on the Oslo Stock Exchange in the period 2000-2015. Using the method introduced by Fama-MacBeth and a portfolio approach, we investigate six different multiples: EV/EBITDA, EV/EBIT, EV/FCFF, P/E, P/FCFE and P/B. During the whole period, only EV/FCFF seems to predict abnormal returns. This result is very surprising. Almost all studies find that EV/EBITDA, EV/EBIT, P/E and P/B predict abnormal returns. In search of an explanation of this surprising result, we divided the whole period (2000-2015) into two sub-periods, one period before the start of the financial crisis in 2008 and one period after. During the first sub-period (2000-2008), the results are closer to our expectations and more in line with prior research. In this period, EV/EBITDA, EV/EBIT, EV/FCFF and P/E seem to predict abnormal returns. A lower multiple was associated with higher abnormal returns. During the last sub-period (2008-2015), none of the multiples seems to predict abnormal returns. These results are quite astonishing. It is an established truth in finance that value stocks (low multiples) provide positive abnormal returns. We believe that the decrease in the risk-free interest rate from normal to record low levels after the financial crisis offers the best explanation of the surprising results. Holding all other variables constant, we show that growth stocks (high multiples) should outperform value stocks (low multiples) in this environment, as growth stocks are more sensitive to changes in the cost of capital.