Separating Winners from Losers among Low
Book-to-Market Stocks using Financial
PARTHA S. MOHANRAM firstname.lastname@example.org
Columbia Business School, 605-A Uris Hall, 3022 Broadway, New York, NY, 10027
Abstract. This paper combines traditional fundamentals, such as earnings and cash ﬂows, with measures
tailored for growth ﬁrms, such as earnings stability, growth stability and intensity of R&D, capital
expenditure and advertising, to create an index – GSCORE. A long–short strategy based on GSCORE
earns signiﬁcant excess returns, though most of the returns come from the short side. Results are robust in
partitions of size, analyst following and liquidity and persist after controlling for momentum, book-to-
market, accruals and size. High GSCORE ﬁrms have greater market reaction and analyst forecast
surprises with respect to future earnings announcements. Further, the results are inconsistent with a risk-
based explanation as returns are positive in most years, and ﬁrms with lower risk earn higher returns.
Finally, a contextual approach towards fundamental analysis works best, with traditional analysis
appropriate for high BM stocks and growth oriented fundamental analysis appropriate for low BM stocks.
Keywords: capital markets, market eﬃciency, ﬁnancial statement analysis, growth, value, book-to-market,
JEL Classiﬁcation: G12, G14, M41
This paper examines whether applying ﬁnancial statement analysis can help investors
earn excess returns on a broad sample of growth, or low book-to-market (BM) ﬁrms.
The BM eﬀect is well documented in ﬁnance research. On average, low BM ﬁrms
earn signiﬁcant negative excess returns, while high BM ﬁrms earn signiﬁcant positive
excess returns. Low BM ﬁrms, also referred to as growth or glamour stocks, have
experienced strong stock performance in prior periods, while high BM ﬁrms, also
referred to as value stocks, have typically underperformed in prior periods. There is
considerable disagreement amongst researchers regarding the cause of the BM eﬀect,
with Fama and French (1992) ascribing it to unobserved risk factors, as opposed to
Lakonishok, Shleifer and Vishny (1994) ascribing it to mispricing.
Financial statement analysis (or fundamental analysis) attempts to separate ex-
post winners from losers on the basis of information from ﬁnancial statements that is
not correctly impounded in prices. A commonly used technique is the Dupont
analysis of return on assets (ROA) and its decomposition into asset turnover and
proﬁt margin, coupled with an analysis of risk factors related to liquidity and sol-
vency. Piotroski (2000) argues that such analyses will be especially eﬀective in high
BM (value) ﬁrms which are often ignored by market participants. He indeed ﬁnds
that ﬁnancial statement analysis eﬀectively separates winners from losers in this
Review of Accounting Studies, 10, 133–170, 2005
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