Similarity based TOPSIS applied to equity portfolio

Abstract

The aim of this thesis is to study applicability of similarity based TOPSIS to equity portfolios. Average annual returns are a basis to analyze portfolios. They are annually computed at same time for all financial ratios by applying similaritybased TOPSIS. To form the ratios, financial values P, B, Ev, Ebit, E, S and Ebitdaare selected from data set quoted on main list of Helsinki stock exchange (HEX) for period 1996-2012. They are chosen because from those values one can form widely used financial ratios. The following financial ratios; EV/Ebit, P/B, P/S, P/E and EV/Ebitda are formed out of the values. Any two of these ratios are joined to form a combination. Since similarity based TOPSIS is multiple criteria decision making, by combining two of the ratios, we examine whether combinations of these ratios bring added value compared to using a single financial ratio. Ranking is done according to closeness coefficient computed from similarity based TOPSIS and five equal size portfolios simultaneously. Portfolios are formed by dividing ranked companies into about equal size sets.

Results obtained generally indicate that 1st portfolios have highest average annual returns while 5th portfolios have the lowest. Similarly best performing portfolios occur when p-values are less than 1, implying that reducing p-values greatly improved performance of portfolios. Specifically combination (EV/Ebit, P/E) has highest average annual returns of 15.71 and corresponding p-value of 0.75. This average annual return is higher than 15.29 for (EV/Ebit) which was the best single ratio. Another interesting comparison is that combination (EV/Ebit, EV/Ebitda) has highest difference between 1st portfolio returns and 5th portfolio returns of 14.49 which is higher than 13,73 for EV/Ebit the highest single ratio difference. Hence we can note that there is added value to use similarity based TOPSIS. The above results are in conformity with critical objectives of the study that; using two criteria instead of one brings added value since higher average returns have been gained this way and also that difference between 1st portfolio returns and 5th portfolio returns is higher when we use combinations of ratios as compared to single financial ratios. Therefore, similarity based TOPSIS approach is practically robust and efficient in analysing portfolios.