Do High Book-to-Market Stocks Offer Returns to Fundamental Analysis in India?

Abstract

The objective of this paper is to investigate if an accounting-based fundamental analysis strategy can help investors earn excess returns on a portfolio of high book-to-market companies in India. The strategy we adopt is based on Piotroski (2000) who identified 9 fundamental signals to form a composite score (F̱SCORE) capable of separating out ex-post winners from losers among high book-to-market companies in the US stock market. However, it is not clear whether the results of such a strategy could be directly applied to Indian stock markets,since there is evidence that market efficiency in India is at the most weak form. Also, during the 1990s when trading and investments were mostly domestic, the markets experienced scams like the Harshad Mehta scam. However, of late, India has been among the most favoured investment destinations in the world. Using the F̱SCORE framework from Piotroski (2000) but a different approach to portfolio formation (for practical purposes) we find convincing evidence that a fundamental analysis based investment strategy for high book-to-market companies can separate winners from eventual losers. We show that portfolios with high F̱SCORE (7 to 9) provide excellent returns far superior to market returns and risk-adjusted returns. Portfolios with low F̱SCORE (0 to 3) offer very poor returns and often underperform the markets or required risk-adjusted returns. A value investor could shift distribution of returns rightwards by investing only in high F̱SCORE companies. Shorting low F̱SCORE could further enhance returns.