Capital Investment and Momentum Strategies. Jiang, G., Li, D., & Li, G. (2012)

The authors are attempting to determine how are momentum returns affected by different levels of capital investment within companies, on average.  They calculate capital investment in three different ways: the capital expenditures as a percentage of fixed assets, the change in capital expenditures from year to year, and the change in accruals (i.e., working capital) from year to year.

Their population includes United States publicly trades stocks during the period 1965 - 2004, and on average, firm's capital expenditures tend to be 14.6% of total capital assets, and their expenditures on capital assets and working capital do not significantly change year to year, on average.  These three measures of investment are also positively correlated with each other; but are not correlated with company size.

Next, the authors explored the momentum returns of this population to see what level of capital investment was made, on average, within different levels of momentum returns.  They sorted the population into portfolio quintiles of prior returns spanning 3 - 12 months, and recorded the returns of those portfolios over holding periods of 3 - 12 months.  Their results corroborate prior studies that find past winners outperform past winners in all formation and holding periods.  In relation to capital investment, they find that the past winners tend to have lower capital investment than past losers, and the level of capital investment tends to have a U-shape with the level of past returns.

Next, the authors isolate the formation/holding period of 6 months to form 5x5 sorts of level of momentum and level of capital investment.  They find that the best performing portfolio tends to have high momentum and high capital expenditure; and the worst performing portfolio tends to have low momentum and high capital expenditure.  The momentum returns tend to increase almost monotonically as the level of capital expenditure increases within the highest ranking momentum stocks, but decreases almost monotonically as the level of capital expenditure increases in the lower momentum rankings.  The momentum returns tend to exhibit a U-shape with increases in the other measures of capital investment (i.e., change in capital expenditures, and change in accruals).  However, the long-only returns of all portfolios (i.e., not the zero-cost portfolios, which are discussed above) tend to decrease as capital investment increases; the reason the higher capital investment portfolio does well for the zero-cost portfolio is because the high momentum returns decrease slower than the low momentum returns at each increase in capital investment.

Next, the authors look at the returns of the zero-cost portfolio within different subperiods within the 1965 - 2004 period.  Within all the subperiods, the momentum returns increase almost monotonically with each increase in capital expenditures.  Within all subperiods, the momentum returns exhibit a U-Shape with each increase in change in capital expenditure and change in accruals.

Next, the authors did a 10x3 sort, with 10 levels of momentum and 3 levels of capital investment; for the momentum, they also looked at different lengths of formation and holding periods from 3 - 12 months.  For the momentum returns, they calculated zero-cost portfolios as the top decile minus the bottom decile.  In line with their prior results, they find the momentum returns to increase monotonically with each increase in level of capital expenditure across all formation/holding periods.  In addition, they find the same U-shape of returns across changes in the change in capital expenditure and change in accruals.

Next, the authors formed a Fama French 3-factor regression (i.e., controlling the returns for market, size, and value returns) to explore the risk-adjusted returns for the portfolios.  They find similar results as the prior results, where the highest alpha portfolio is the one with the highest momentum and highest capital expenditure, and the lowest alpha portfolio is the one with the lowest momentum and highest capital expenditure.  The zero-cost alpha tends to increase as capital expenditures increase, and the portfolio alphas tend to decrease at each increase in capital expenditure.  When looking at the change in capital expenditure and change in accrual methods, we see a decrease in portfolio alphas as capital investment increases, but the zero-cost alphas exhibit a U-shape in line with the results of prior tables. 

Citation: Jiang, G., Li, D., & Li, G. (2012). Capital investment and momentum strategies. Review of Quantitative Finance & Accounting, 39(2), 165–188.

Link to paper: https://doi.org/10.1007/s11156-011-0250-3

Abstract: The main purpose of this paper is to investigate whether capital investment can affect stock price momentum. We provide empirical evidence that momentum strategies tend to be more profitable for stocks with large capital investment or investment changes. We present a simple explanation for our empirical results and show that our finding is consistent with the behavioral finance theory that characterizes investors' increased psychological bias and the more limited arbitrage opportunity when the estimation of firm value becomes more difficult or less accurate.