Pricing and mispricing of accounting fundamentals: Global evidence

Abstract

This paper extends the fundamentals-based valuation model in Nichols et al. (2017) to global, developed equity markets. The model is able to explain, on average, 81% of the cross-sectional share price variation among global stocks. To be applicable among international markets, actual cash-flow streams instead of clean surplus accounting figures are used to reflect the different importance of dividends and share repurchases around the world. Firms identified as undervalued outperform overvalued firms by 0.62% p.m. after controlling for size, book-to-market, operating profitability, investment, and momentum. This premium is further not explained by lottery-like stock preferences (MAX, idiosyncratic volatility, skewness), mispricing related variables (FSCORE, ΔXFIN), or stock issuances. In support of a mispricing related explanation, we detect a significant post publication return decline in the easily exploitable long portfolio leg comprising undervalued stocks. Together with our analysis on investor sentiment, portfolio transitions, and arbitrage asymmetry, we provide evidence that deviations of the share price from the model’s estimated value indicate actual mispricing and according returns are unlikely to be a compensation for risk exposure.