Value-to-price

I will post some results from relevant accounting studies over the course of the semester. The first I'd like to highlight relates to today's discussion of the residual income model. The paper I want to highlight examines the predictive ability of the residual income value to price ratio over future stock returns. The paper is by Rich Frankel and Charles Lee, who published "Accounting valuation, market expectation, and cross-sectional stock returns" in the Journal of Accounting Research in 1998.


In their paper they find that over holding periods of 36 months, a strategy based on buying high value to price stocks (i.e., stocks the market undervalues relative to the model of fundamental value) and selling stocks low value to price stocks (i.e., stocks the market overvalues relative to the model of fundamental value) earns over a 45% return.

Do you think that these results are likely to hold in our current economy?

Quantitative analysis

A large part of our course is about how financial statement analysis can be used to help us gain insights into the valuation (and potential misvaluation) of stocks. One of the leading investment firms using quantitative investing strategies is Barclays Global Investors. This BusinessWeek article "Outsmarting the market" provides some insights into how their operations work.