Value Investing and Financial Statement Analysis

This study investigates whether a simple accounting-based fundamental analysis can outperform the market. In this study, I use a fundamental signal (F_SCORE) to discriminate between eventual winners and losers. F_SCORE is based on a combination of traditional fundamentals such as ROA, cash flow from operations, and operating margin. I demonstrate that the mean return can be increased by at least 7.8% through hedging strategy that buys high F_SCORE firms and that shorts low F_SCORE firms. In particular, an investment strategy that buys high book-to-market (BM) firms with high F_SCORE and shorts low BM firms with low F_SCORE earns a 17.6% annual return. In other words the results are robust across a variety of partitions including size, share price, and trading volume. This study reveals that F_SCORE can predict future earnings. Further, empirical results do not support a risk-based explanation for the investment strategy. Overall, the results of the present study suggest that life cycle hypothesis advocated by Lee and Swaminathan[2000] holds true.