FREE New Issue of Empirical Finance Research Newsletter (including stock screen results)
The February issue of Empirical Finance Research Newsletter has been published. We're pleased to bring it to you absolutely FREE in partnership with Wes Gray and Andy Kern of Empirical Finance, LLC. This month's newsletter includes the results of a stock screen that should not be missed.
February 2009 — Empirical Finance Research Newsletter on Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers, a paper by Joseph Piotroski
Abstract:
This paper examines whether a simple accounting-based fundamental analysis strategy, when applied to a broad portfolio of high book-to-market firms, can shift the distribution of returns earned by an investor. I show that the mean return earned by a high book-to-market investor can be increased by at least 7 percent annually through the selection of financially strong high BM firms while the entire distribution of realized returns is shifted to the right. In addition, an investment strategy that buys expected winners and shorts expected losers generates a 23 percent annual return between 1976 and 1996 and the strategy appears to be robust across time and to controls for alternative investment strategies. Within the portfolio of high BM firms, the benefits to financial statement analysis are concentrated in small and medium sized firms, companies with low share turnover and firms with no analyst following, yet this superior performance is not dependent on purchasing firms with low share prices. A positive relationship between the sign of the initial historical information and both future firm performance and subsequent quarterly earnings announcement reactions suggests that the market initially underreacts to the historical information. In particular, 1/6th of the annual return difference between ex ante strong and weak firms is earned over the four three-day periods surrounding these quarterly earnings announcements. Overall, the evidence suggests that the market does not fully incorporate historical financial information into prices in a timely manner.
Conclusions:
The paper goes into great detail and outlines many tests to see if the results are dependent on size factors, liquidity factors, analyst following factors, etc. The bottom line is that fundamental analysis works no matter how you cut it and the FSCORE works extremely well. Nevertheless, as the paper shows, the scale of how well the FSCORE will work really depends on where you implement it. Not surprisingly, the best place to implement the FSCORE is in underfollowed, low liquidity, small cap stocks. If you do this, you will probably make a small fortune over time. Caveat: Past performance is no guarantee of future results.
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Disclosure: No position.