Does the Incongruence of Market Expectations with Fundamentals explain Stock Return Patterns?

45 Pages Posted: 7 Dec 2020 Last revised: 24 Nov 2021

See all articles by Bernd Huefner

Bernd Huefner

Friedrich Schiller University Jena, Faculty of Economics and Business Administration

Marcel Rueenaufer

Friedrich Schiller University Jena, Faculty of Economics and Business Administration

Martin Boesch

affiliation not provided to SSRN

Date Written: August 6, 2021

Abstract

This paper uses accounting-based reverse engineering of market expectations to identify potentially mispriced stocks. Building upon the “errors-in-expectations” hypothesis, we develop a theoretically funded yet practical tool for stock screening in this paper. We use the Ohlson (1995) model to apply and extend the framework from the first paper by connecting total stock returns to accounting-based fundamentals and (changes in) expected residual income levels, both in the short-term and long-term future. In a similar manner to Piotroski & So (2012), we construct a scoring index – VScore. VScore includes both fundamental data and short-term market expectations that stem from the theoretical framework we provide beforehand, where short-term expectations perform a verifying function for historical fundamentals for the determination of quality. We document that the book-to-price (B/P) effect is concentrated among firms for which long-term speculation is simultaneously incongruent to the underlying fundamentals and short-term expectation (stocks that combine cheapness with quality), indicating that those stocks are interesting subjects for a more extensive fundamental analysis.

Keywords: Reverse Engineering, Residual Income Valuation, Financial Statement Analysis, Fundamental Investor, Value Investing, Stock Screening

JEL Classification: M41, G11, G12, G14, G17, G32

Suggested Citation

Huefner, Bernd and Rueenaufer, Marcel and Boesch, Martin, Does the Incongruence of Market Expectations with Fundamentals explain Stock Return Patterns? (August 6, 2021). Available at SSRN: https://ssrn.com/abstract=3741355 or http://dx.doi.org/10.2139/ssrn.3741355

Bernd Huefner

Friedrich Schiller University Jena, Faculty of Economics and Business Administration ( email )

Germany

Marcel Rueenaufer (Contact Author)

Friedrich Schiller University Jena, Faculty of Economics and Business Administration ( email )

Germany

Martin Boesch

affiliation not provided to SSRN

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