Risk and Return to Value, Glamour and Contrarian Strategies

By

ACKNOWLEDGEMENT

I would take this opportunity to thank my research supervisor, family and friends for their support and guidance without which this research would not have been possible.

DECLARATION

I, [type your full first names and surname here], declare that the contents of this dissertation/thesis represent my own unaided work, and that the dissertation/thesis has not previously been submitted for academic examination towards any qualification. Furthermore, it represents my own opinions and not necessarily those of the University.

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ABSTRACT

Marketing managers can increase shareholder value by structuring a customer portfolio to reduce the vulnerability and volatility of cash flows. This article demonstrates how financial portfolio theory provides an organizing framework for (1) diagnosing the variability in a customer portfolio, (2) assessing the complementarily/similarity of market segments, (3) exploring market segment weights in an optimized portfolio, and (4) isolating the reward on variability that individual customers or segments provide. Using a seven-year series of customer data from a large business-to-business firm, the authors demonstrate how market segments can be characterized in terms of risk and return. Next, they identify the firm's efficient portfolio and test it against (1) its current portfolio and (2) a hypothetical profit maximization portfolio. Then, using forward- and back-testing, the authors show that the efficient portfolio has consistently lower variability than the existing customer mix and the profit maximization portfolio. The authors provide guidelines for incorporating a risk overlay into established customer management frameworks. The approach is especially well suited for business-to-business firms that serve market segments drawn from diverse sectors of the economy.

TABLE OF CONTENTS

ACKNOWLEDGEMENTII

DECLARATIONIII

ABSTRACTIV

CHAPTER 1: INTRODUCTION1

Background of the Study1

Problem Statement1

Research Aims and Objectives2

Rationale/ Nature of the study2

CHAPTER 2: LITERATURE REVIEW3

Financial Portfolio Theory3

Cash Flow Stability and Firm Value5

Customer Portfolios versus Financial Portfolios6

Customer Portfolio: Risk and Reward12

Customer Beta and Customer Reward Ratio12

CHAPTER 3: METHODOLOGY14

Research Design14

Analysis Plan14

Stage 1: Assessing Differences in Variability among Customer Segments15

Stage 2: Transactional Segmentation17

Stage 3: Identifying the Efficient Frontier and Building an Efficient Customer Portfolio17

Stage 4: Testing the Efficient Portfolio20

Stage 5: Revising the Current Customer Portfolio toward an Efficient Portfolio21

Data Analysis Conclusion22

CHAPTER 4: DISCUSSION AND ANALYSIS24

The Efficient Versus the Profit-Maximizing Customer Portfolio25

Implementing the Portfolio Approach26

CHAPTER 5: CONCLUSION28

Limitations and Further Research28

Conclusion29

REFERENCES31

APPENDIX A CASH FLOW VARIABILITY BY CUSTOMER TYPE42

Contractual Relationships42

Size of Business43

Industry Classification43

CHAPTER 1: INTRODUCTION

Background of the Study

Since the inception of weighing risk and return in the light of glamour and value strategies, a substantial literature in finance and accounting documents that future stock returns are predictable using various measures of relative value. The collective evidence from this literature highlights the tendency of “value” stocks to outperform the market while “glamour” firms underperform. The source of these returns remains a subject of considerable debate. While some argue that the returns reflect compensation for risk; others suggest that the glamour effect is an artifact of pricing. Mispricing based explanations contend that measures of relative value, such as firm-book-to-market or earnings to-price ratios, reflect overly optimistic performance expectations for glamour firms and overly pessimistic expectations for value firms; as a ...