Study on stock portfolios' profitability with gearing ratio.

Abstract

This study investigates the effect of gearing on the profitability of stock portfolios. The main objective is to find the level of gearing which would yield the best risk-return trade-off. The study uses the Sharpe Ratio as the performance measure of risk-return trade-off. The results show a significant difference in the calculated Sharpe Ratio between portfolios of gearing stocks and the market. The outcome of the analysis by industry is that portfolios of stocks in industries with low gearing returns good performance. Additional analysis by company size reveals that stocks of small size companies with high gearing outperformed the market. This provides evidence that the best risk-return trade-off in excess of market returns is attainable based on gearing adjustments. It therefore highlights the possibility of using gearing ratios as predictors of the profitability of stocks. Investors may pinpoint potential growth stocks via the companies' gearing level.