5-Year Average Return on Investment Backtest

I decided to also backtest the 5-Year Average Return on Investment (ROI) in order to see how it compared to my recent 5-Year Average Return on Equity Backtest. We can also compare this 5-year average ROI backtest to the trailing twelve-month Return on Investment ratio backtest performance I ran a few weeks ago.

I used the data and backtesting tool provided by Portfolio123. The Portfolio123 backtesting eliminates the problem of survivorship bias by using point-in-time and retaining data on stocks that have gone to zero. This backtest uses the same filtered universe of stocks as my recent 5-Year Average Return on Equity Backtest. I’ve designed the filtering criteria for this backtest specifically for individual investors and with a focus on enhancing data quality. The filters include the following criteria:

  1. No OTC stocks. Stocks not traded on the New York Stock Exchange, NASDAQ, or American Stock Exchange markets are excluded. The quality of fundamental stock data for OTC can be somewhat lower and less timely that that for stocks traded on major exchanges.
  2. No ADRs. Fundamental data for foreign American Depositary Receipt can include errors due to currency exchange, different accounting standards, and share count.
  3. Liquidity test. The average daily total amount traded over the past 60 trading days must be larger than $100,000.  This amount was selected so that a $1 million dollar portfolio could hold 100 positions and that each new $10,000 position would not exceed 10 percent of a day’s trading volume. The liquidity test also ensures that the backtest has reliable market price information for any of the stocks that are being tested.
  4. Market Cap > $50 million. Nano cap stocks are excluded to help improve data quality. This filter also ensures that positions in a modest sized portfolio never exceed one percent of shares outstanding or the available float for a company.
  5. Price > $1. True penny stocks are excluded due to various information issues and manipulation of these stocks.
  6. ROI 5-Year Average  != NA. This filter insures we are looking at stocks that actually have valid data for the 5-year average Return on Investment ratio.

After these filters are applied, we are left with approximately 3,000 to 3,700 stocks. These stocks are then ranked by the criteria being tested; in this case, we are testing 5-Year Average Return on Investment. The lowest 20 percent of stocks ranked by 5-year average return on investment are placed in the first quintile and the next 20 percent in the second quintile and so forth until we have five portfolios of stocks. The portfolios are rebalanced every 12-months and compounded annually to more realistically replicate what an individual investor might be expected to do to avoid higher short-term capital gains tax and trading costs. The following 5 charts display the quintile returns for 5-yr. average ROI in red and the S&P 500 Equal Weight Index in blue.  The first quintile includes the companies that had the lowest 5-year average ROI and the 5th quintile includes the companies that had the highest 5-year average ROI.

Return on Investment 5-Year Average Quintile Returns – 2000 – 2014

 

Return on Investment 5-Year Average Backtest 1st Quintile
ROI 5-Year Average Backtest 1st Quintile
Return on Investment 5-Year Average Backtest 2nd Quintile
ROI 5-Year Average Backtest 2nd Quintile
Return on Investment 5-Year Average Backtest 3rd Quintile
ROI 5-Year Average Backtest 3rd Quintile
Return on Investment 5-Year Average Backtest 4th Quintile
ROI 5-Year Average Backtest 4th Quintile
Return on Investment 5-Year Average Backtest 5th Quintile
ROI 5-Year Average Backtest 5th Quintile

 

Summary of Results for the 5-Year Average Return on Investment Backtest

15-year Backtest Results for Return on Investment 5-Year Average
15-year Backtest Results for ROI 5-Year Average

 

Average annual excess returns from 2000 to 2014 for the ROI 5-Year Average
Average annual excess returns from 2000 to 2014 for the ROI 5-Year Average

The results for my backtest of the 5-Year Average Return on Investment is similar to the previous trailing twelve-month ROI results. While the first quintile produced the lowest returns, the 4th quintile produce the highest returns. This is a bit different than the results we saw for the average excess returns for the 5-year average ROE. Seeing lower excess returns for the top quintile is consistent with the theory that the most profitable companies often attract the most fierce competition.

I encourage you to try backtesting other time periods for ROI and ROE, such as 3 and 7-year averages. Just sign up for a free 30-day trial at Portfolio123 and report your findings in the comments section below.

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