Fundamental Analysis Future Earnings, and Stock Prices
Posted: 8 Jul 1998
This paper studies the information links that connect detailed financial statement data and security prices. We establish empirically the underlying relations between rules of fundamental analysis and: 1) analysts' earnings forecast revisions, 2) actual future earnings changes and 3) security returns. We find evidence that some but not all of the fundamental signals are related to subsequent earnings changes and analysts' revisions as hypothesized. Paradoxically, contemporaneous security returns reveal that, in the eyes of investors, the set of fundamental signals contain information orthogonal to analysts' revisions. Additional evidence suggests one explanation for this result is that analysts' forecast revisions are inefficient with respect to the future earnings information contained in some of the fundamental signals. One practical implication of our findings is that if analysts were to process efficiently the information in the fundamental signals, it would be sufficient to eliminate the well-documented phenomenon of analyst underreaction to prior earnings news.
JEL Classification: G14, M41
Suggested Citation: Suggested Citation