Gearing Doesn’t Matter For Return

Gearing Doesn’t Matter For Return

At A. Stotz Investment Research we look at investing through our FVMR framework: Fundamentals, Valuation, Momentum, and Risk. To come up with investment strategies for portfolios that should generate above-benchmark return we do a lot of backtesting. Below you can see a few factors that we consider when we look at the Risk of an investment.

FVMR Framework

We previously tested a Fundamentals factor, return on assets, in Investing Is Not Just Buying Highly Profitable Companies, a Valuation factor, price-to-book, in Dirt Cheap Stocks Are Too Risky, and Momentum in Momentum Is a Good Start to Beat the Market. In this post, we will test a Risk factor: gearing.

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Investing in stocks with low gearing (net debt-to-equity) generates outperformance.


When backtesting, you should use original statements (and not re-stated) to avoid hindsight bias. When you backtest you also need to know and adjust for when a company closes its books. A company may close its books in December but that data is only available some months after on the announcement date. Focus on the announcement date when you backtest.

This was our process to come up with a global universe to test our hypothesis: 

  • Started with all companies listed anywhere in the world with a market capitalization of more than or equal to US$40m, which left us with 26,564 companies
  • Applied a US$50m minimum market capitalization screen, which left us with 25,039 companies
  • Filtered out illiquid stocks with a three-month average daily turnover of less than US$250,000 and was left with 16,270 stocks
  • Excluded stocks of financial companies
  • Excluded companies that did not close their books in December
  • We removed 7,073 stocks (43%), leaving 9,197


FVMR Framework

  • On the last day of March of each year we ranked all stocks from highest ROA to lowest
  • Divided that list up into deciles
  • Measured the share price performance of each decile over the coming 12 months
  • Re-ranked after 12 months and reallocated the money of each decile into the new stocks included in each decile
  • Repeated for 10 years


By looking at the chart below it doesn’t look like investing in low-gearing companies is a winning strategy. Gearing and return seem to be unrelated.

FVMR Framework

Adjusting for risk does not make any difference if anything it makes the outcomes look even less related.

FVMR Framework


We can’t find any support for our hypothesis that low-gearing companies would generate higher return. Investing based only on low gearing doesn’t work.

It’s not uncommon when backtesting that you find that a factor doesn’t work. If you want to see a single factor that actually works quite well, check out: Momentum Is a Good Start to Beat the Market.

What do you think about these findings on gearing? Did you expect another outcome?

Share your ideas and experience in a comment below.

DISCLAIMER: This content is for information purposes only. It is not intended to be investment advice. Readers should not consider statements made by the author(s) as formal recommendations and should consult their financial advisor before making any investment decisions. While the information provided is believed to be accurate, it may include errors or inaccuracies. The author(s) cannot be held liable for any actions taken as a result of reading this article.

Article By A. Stotz Investment Research, Become A Better Investor

In 1992 Dr. Andrew Stotz, CFA, left a management career at Pepsi-Cola in California to teach finance in Thailand. In 1993, he found his life calling as a financial analyst, a job for which he was eventually voted #1 in Thailand. In the second half of his 20-year career in investment banking, Dr. Stotz was a Head of Research, leading teams of financial analysts. He served as a two-term president of CFA Society Thailand and now runs his firm, A. Stotz Investment Research, which provides research and tools for institutions and high-net-worth investors and helps CEOs make their companies financially world class.
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