Identifying Overvalued Equity

60 Pages Posted: 21 May 2008 Last revised: 12 May 2014

Messod Daniel Beneish

Indiana University - Kelley School of Business - Department of Accounting

D. Craig Nichols

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: June 26, 2009

Abstract

We develop a profile of overvalued equity, and show that firms meeting this profile experience abnormal stock returns net of transaction costs of -22 to -25 percent over the twelve months following portfolio formation. We show our model is distinct from predictors proposed in prior work, and our results robust to alternative measurements of expected returns. We also show that overvaluation is not confined to small firms and that institutions do not trade as if they identify overvalued equity. The profitable predictability we document suggests a pricing anomaly relating to the 2.5% of the firms in the population that our model identifies as substantially overvalued. Although we believe markets are generally efficient within the bounds of transaction costs, our evidence suggests that violations of minimally rational use of publicly available information do occur. To the extent that anomalies disappear or attenuate once documented in the literature (Doukas et al. 2002, Schwert 2003), our results are of interest to financial economists and investors.

Keywords: Overvalued Equity, Agency Costs, Earnings Manipulation, Earnings Overstatement, Financial Fraud, O-Score

JEL Classification: M4, M43, G11, G12, G14, K22

Suggested Citation

Beneish, Messod Daniel and Nichols, D. Craig, Identifying Overvalued Equity (June 26, 2009). Johnson School Research Paper Series No. #09-09. Available at SSRN: https://ssrn.com/abstract=1134818 or http://dx.doi.org/10.2139/ssrn.1134818

Messod Daniel Beneish (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2628 (Phone)
812-855-4985 (Fax)

D. Craig Nichols

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

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