Fundamental Analysis, Future Earnings, and Stock Prices

• Published in: Journal of accounting research 1997-04, Vol.35 (1), p.1-24
• Main Authors: Abarbanell, Jeffrey S., Bushee, Brian J.
• Format: Article
• Language: English
• Subjects: Accounting; Analytical forecasting; Capital expenditures; Coefficients; Earnings forecasting; Earnings per share; Financial statement analysis; Forecasting models; Impact analysis; Investments; Investors; Profits; Regression analysis; Regression coefficients; Revisions; Standard deviation; Statistical forecasts; Stock prices; Studies; Variable coefficients; Variables
• ISSN: 0021-8456; 1475-679X
• DOI: 10.2307/2491464

A paper investigates how detailed financial statement data (fundamental signals) enter the decisions of market participants by examining whether current changes in the signals are informative about subsequent earnings changes. The approach is consistent with the view expressed by Penman (1992) and others that predicting accounting earnings, as opposed to explaining security returns, should be the central task of fundamental analysis. Studying the links between fundamental signals and future earnings changes allows the validity of the economic intuition that underlies the original construction of the signals to be tested directly. The results support the validity of much of the economic intuition that has been used to link current accounting information to earnings changes. Similarly, it is found that analysts' revisions of earnings forecasts are associated with many, but not all, of the signals that predict future earnings. Tests based on contemporaneous security returns reveal that the fundamental signals convey value-relevant information orthogonal to forecast revisions.