Question

Explain the market condition under which fundamental analysis can lead to abnormal return

Answer 1

Fundamental analysis is a method of evaluating a security in an effort to assess its intrinsic value, by examining related economic, financial, and other qualitative and quantitative factors.

market condition under which fundamental analysis can lead to abnormal return

We have to examine whether the application of basic concepts of fundamental analysis can yield significant abnormal returns so by using a collection of signals that reflect traditional rules of fundamental analysis related to existing or occurring changes in inventories, accounts receivables, gross margins, selling expenses, capital expenditures, effective tax rates, inventory methods, audit qualifications, and labour force sales productivity, for example we form portfolios that earn an average 12 month cumulative size-adjusted abnormal return of 13.2 percent. We find evidence that the fundamental signals provide information about future returns that is associated with future earnings news. Moreover, a significant portion of the abnormal returns is generated around subsequent earnings announcements. These findings are consistent with the underlying focus of fundamental analysis on the prediction of earnings. Significant abnormal returns to the fundamental strategy are not earned after the end of one year of return cumulation, indicating little support for the idea that the signals capture information about multiple-year-ahead earnings not immediately impounded in price or about long-term shifts in firm risk. Additional analysis on a holdout sample suggests that the strategy continues to generate abnormal returns in a period subsequent to the introduction of the fundamental signals in the literature, and contextual analyses indicate that the strategy performs better for certain types of firms.