Deep Fundamental Analysis and Future Stock Returns

Can a deep dive into company accounting data reliably predict stocks that will underperform? In their February 2019 paper entitled “Earnings Quality on the Street”, Urooj Khan, Venkat Peddireddy and Shivaram Rajgopal examine proprietary reports from a research firm that screens publicly available accounting data for over 9,000 North American and 5,500 other global companies to identify those in poor financial health (book value and earnings quality). Mutual funds, money managers, hedge funds, insurance companies, banks, CPA firms, law firms and individual investors subscribe to these reports. The research firm emphasizes importance of industry-specific metrics, evaluating whether each metric for a company is abnormal (aggressively optimistic) relative to peers and to its own history. Using 1,029 reports on aggressive reporting practices for 348 unique companies, and associated future daily stock returns, during 2004 through 2015, they find that:

(more…)