Fundamental analysis and future firm performance - Nordic evidence

Abstract

This study examines the relation between fundamental analysis, future earnings changes, and future stock prices. Fundamental analysis is based on 7 fundamental signals derived from financial statements measuring contemporaneous corporate financing activities and current changes in inventories, accounts receivable, SG&A expenses, gross margin, asset turnover, and labor force efficiency.

First, the relation between fundamental signals and subsequent earnings changes is examined. After establishing these relations, it is investigated whether positive abnormal returns can be earned by exploiting the information conveyed by fundamental signals as a trading strategy. This is tested by forming annual zero net investment (hedge) portfolios that buy (sell) fundamentally strong (weak) companies. Analyses are conducted using OLS regressions. The sample consists of companies listed in OMX Helsinki, OMX Stockholm, OMX Copenhagen and Oslo Børs between 2006 and 2013. Sample size is 1,508 firm year observations.

Findings provide partial evidence on the usefulness of fundamental analysis in predicting future earnings changes. However, the relation between some fundamental signals and future earnings changes is opposite to expected. Findings are not fully consistent with prior literature. Fundamental trading strategy on aggregate level does not yield statistically significant abnormal returns. However, labor force and inventory signals have a positive relation to future earnings changes and future abnormal returns. This implies market inefficiency in digesting the forward-looking information conveyed by these signals. Abnormal return to asset turnover signal is not consistent with its relation to future earnings changes, posing some doubt on the suggested interpretation of observed abnormal returns. However, the observed abnormal returns to inventory and labor force signals are robust to various tests.

All data are available from public sources.