Prediction of Stock Returns for Growth Firms—A Fundamental Analysis

This paper examines whether fundamental analysis involving two set of signals named traditional and growth, when applied on growth stock it differentiates the extreme performers. Attempt is also made to investigate if fundamentally strong firms earn significant excess returns in identifying which set of signals are more effective in differentiating fundamentally strong and weak firms. The study is conducted on the sample of 180 low book to market firms listed with National Stock Exchange, during the period 1998 to 2007. Traditional fundamental signals depicting firm's profitability, cash performance, operating efficiency and liquidity are applied to the set sample firms. The score based on traditional signals is F_score and results show that F_score strategy is statistically insignificant in differentiating the returns of high and low group firms. Growth signals related with the firm's earnings, growth, research and development, capital expenditure and advertising expenditure are applied to the set of the sample firms. The score based on the growth signals is G_score and it shows effectiveness of this investment strategy as compared with the strategy based on traditional fundamental signals in one and two year ahead period. The results indicate that fundamental analysis based on growth signals is very successful in differentiating between the firms that are likely to perform well in future and may perform poorly among the low book to market firms.