Regression regularization techniques show that deviations of accounting fundamentals from their preceding moving averages forecast drifts in equity market prices. Deviations-based predictability survives a comprehensive set of prominent anomalies. The profitability applies strongly to the long leg and survives value weighting and excluding microcaps. We provide evidence that the predictability arises because investors anchor to recent means of fundamentals. A factor based on our fundamentals-based index yields economically significant intercepts after controlling for a comprehensive set of other factors, including those based on profit margins and earnings drift.
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The authors are grateful to two anonymous referees, an associate editor, and the editor (Gustavo Manso) for insightful and constructive comments. The authors also thank Yakov Amihud, Chen Yao, Buly Cardak, Mohammad Al Mamun, Jan Libich, Si Cheng, Sudha Krishnaswami, Feifei Li, Matthew Lutey, Tarun Mukherjee, Gans Narayanamoorthy, Luca Pezzo, Guofu Zhou, Jing Zhao, and Xue Wang, as well as seminar participants at Chinese University of Hong Kong (Shenzhen), Korean Advanced Institute of Science and Technology, Korean University, La Trobe University, National University of Singapore, National University of Taiwan, University of New Orleans, Nanyang Technological University, Tsinghua University (SEM), Xiamen University, and the 2018 China International Conference in Finance, for valuable comments and suggestions.
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- accounting fundamentals
- capital markets
- cross-section of returns
- regression regularization techniques