Separating winners from losers among low book-to-market stocks using financial statement analysis

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 low BM stocks.