Fundamental Analysis and the Prediction of Earnings

Dyna Seng,Jason R Hancock

doi:10.5539/ijbm.v7n3p32

Abstract

This paper takes fundamental analysis research beyond the spatial and temporal bounds of previous studies. Weinvestigate how detailed financial statement data enter the decisions of market makers by examining how currentchanges in the fundamental signals chosen can provide information on subsequent earnings changes. Usingglobal data from 1990 to 2000, we extend the body of research using fundamental signals for prediction of futureearnings changes. Contextual factors that may influence this predictive ability are also investigated. Resultsindicate that the fundamental signals are significant predictors of both short- and long-term future earningschanges. Contextual factors that include prior earnings news, industry membership, macroeconomic conditionsand country of incorporation are all demonstrated to influence this relationship. Research results provideevidence to support the use of fundamental analysis.

Highlights

Capital markets research on fundamental analysis has become extremely popular in recent years, in part because of mounting evidence in the financial economics literature against the efficient markets hypothesis (Kothari, 2001, p.109)
We investigate whether the information contained in fundamental signals about future earnings is conditioned upon the state of the economy or industry, following Lev and Thiagarajan (1993) and Abarbanell and Bushee (1997)
We extend investigations with examination of the predictive link between the fundamental signals and future earnings change by introducing a country of incorporation as a new contextual factor in order to look for a possible country effect

Summary

Introduction

Capital markets research on fundamental analysis has become extremely popular in recent years, in part because of mounting evidence in the financial economics literature against the efficient markets hypothesis (Kothari, 2001, p.109). Studies that employ fundamental analysis to forecast earnings and future stock returns (i.e., a test of market efficiency) include Ou and Penman (1989a, b), Holthausen and Larcker (1992), Lev and Thiagarajan (1993) and Abarbanell and Bushee (1997, 1998). Fundamental analysis involves the use of current and past financial statements in conjunction with industry and economic data in order to determine firms’ intrinsic value and identify mispriced securities (Kothari, 2001). We investigate whether the information contained in fundamental signals about future earnings is conditioned upon the state of the economy or industry (contextual factors), following Lev and Thiagarajan (1993) and Abarbanell and Bushee (1997)

Objectives

Results

Conclusion