Separating Winners from Losers Among Low Book-to-Market Stocks Using Financial Statement Analysis

46 Pages Posted: 5 May 2003

See all articles by Partha S. Mohanram

Partha S. Mohanram

University of Toronto - Rotman School of Management

Date Written: April 2004


This paper tests whether a strategy based on financial statement analysis of low book-to-market (growth) stocks is successful in differentiating between winners and losers in terms of future stock performance. I create an index (G_SCORE) based on a combination of traditional fundamentals such as earnings and cash flows and measures appropriate for growth firms such as the stability of earnings and growth and the intensity of R&D, capital expenditure and advertising. A strategy based on buying high G_SCORE firms and shorting low G_SCORE firms consistently earns significant excess returns. The results are robust across partitions based on size, stock price, analyst following, exchange listing and prior performance and are not affected by the inclusion or omission of IPO firms. The excess returns persist after controlling for well documented risk and anomaly factors such as momentum, book-to-market, accruals and size. The stock market in general and analysts in particular are much more likely to be positively surprised by firms whose growth oriented fundamentals are strong, indicating that the stock market fails to grasp the future implications of current fundamentals. Further, the results do not support a risk based explanation for the book-to-market effect as the strategy returns positive returns in all years, and firms that ex-ante appear less risky have better future returns. To conclude, one can use a modified fundamental analysis strategy to identify mispricing and earn substantial abnormal returns.

Keywords: Fundamental Analysis, Financial Statement Analysis, Growth Firms, Low Book-to-Market Firms

JEL Classification: M41, G12, G14

Suggested Citation

Mohanram, Partha S., Separating Winners from Losers Among Low Book-to-Market Stocks Using Financial Statement Analysis (April 2004). Available at SSRN: or

Partha S. Mohanram (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4

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