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Financial Statement Analysis and the Prediction of Stock Returns

In: Business and Management

Submitted By birdyoo
Words 13257
Pages 54
Journal of Accounting and Economics 11 (1989) 295-329. North-Holland

FINANCIAL STATEMENT ANALYSIS AND THE PREDICTION OF STOCK RETURNS* Jane A. O U
Santa Clara university, Santa Clara, CA 95053, USA

Stephen H. P E N M A N
Universi(v of California, Berkeley, CA 94720, USA

Received January 1988, final version received April 1989 This paper performs a financial statement analysis that combines a large set of financial statement items into one summary measure which indicates the direction of one-year-ahead earnings changes. Positions are taken in stocks on the basis of this measure during the period 1973-1983, which involve cancelling long and short positions with zero net investment. The two-year holding-period return to the long and short positions is in the order of 12.5%. After adjustment for 'size effects' the return is about 7.0%. These returns cannot be explained by nominated firm risk characteristics.

1. Introduction
F i n a n c i a l s t a t e m e n t analysis identifies aspects of financial statements that a r e r e l e v a n t to investment decisions. O n e goal of the analysis is to assess firm value from financial statements. M u c h empirical a c c o u n t i n g research has a t t e m p t e d to discover value-relevant accounting attributes in o r d e r to enhance financial s t a t e m e n t analysis. T h e a p p r o a c h taken in this work assumes that m a r k e t price is sufficient for d e t e r m i n i n g firms' values a n d thus serves as a b e n c h m a r k against which to evaluate the i n f o r m a t i o n in a c c o u n t i n g measures. A c c o u n t i n g a t t r i b u t e s are inferred to be value-relevant because they are c o n t e m p o r a n e o u s l y statistically associated with stock prices. F o r example, the s e m i n a l w o r k of Ball and Brown (1968) a n d the m a n y successive ' i n f o r m a t i o n c o n t e n...

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