Abnormal Returns to a Fundamental Analysis Strategy
Author(s): Jeffery S. Abarbanell (University of North Carolina at Chapel Hill) and Brian J. Bushee (Harvard University)
Source: The Accounting Review, Vol. 73, No. 1 (Jan., 1998), pp. 19-45
Published by: American Accounting AssociationStable URL: http://www.jstor.org/stable/248340


ABSTRACT: We examine whether the application of fundamental analysis can
yield significant abnormal returns. Using a collection of signals that reflect
traditional rules of fundamental analysis related to contemporaneous changes
in inventories, accounts receivables, gross margins, selling expenses, capital
expenditures, effective tax rates, inventory methods, audit qualifications, and
labor force sales productivity, we form portfolios that earn an average 12-
month cumulative size-adjusted abnormal return of 13.2 percent. We find evidence
that the fundamental signals provide information about future returns
that is associated with future earnings news. Moreover, a significant portion
of the abnormal returns is generated around subsequent earnings announcements.
These findings are consistent with the underlying focus of fundamental
analysis on the prediction of earnings. Significant abnormal returns to the fundamental
strategy are not earned after the end of one year of return cumulation,
indicating little support for the idea that the signals capture information
about multiple-year-ahead earnings not immediately impounded in price or
about long-term shifts in firm risk. Additional analysis on a holdout sample
suggests that the strategy continues to generate abnormal returns in a period
subsequent to the introduction of the fundamental signals in the literature, and
contextual analyses indicate that the strategy performs better for certain types
of firms (e.g., firms with prior bad news).
Key Words: Fundamental analysis, Market efficiency, Stock returns, Contextual
analysis.
Data Availability: All data are available from public sources.
We would like to acknowledge the helpful comments of Andy Alford, Vic Bernard, Ilia