Can Any Fundamental System Pick Winners?

Can Any Fundamental System Pick Winners?

Research has also been done on whether above-average returns can be earned by employing trading systems based on press announcements of new fundamental information. The answer seems to be a clear no.

Systems have been devised in which a news event such as the announcement of an unexpectedly large increase in earnings or a stock split triggers a buy signal. But the evidence points mainly toward the efficiency of the market in adjusting so rapidly to new information that it is impossible to devise successful trading strategies on the basis of such news announcements (these tests are often referred to as tests to the “semi-strong” form of the random-walk hypothesis. The “weak” form asserts that past price information cannot be exploited to develop successful trading strategies. The “semi-strong” form says that no publicly announced news can be exploited by investors to obtain above-average returns.)

Research indicates that, on average, stock prices react well in advance of unexpectedly good or unexpectedly bad earnings reports. In other words, the market is usually sufficiently efficient at anticipating published earnings announcements that investment strategies involving purchases or sales of stocks after the publication of those announcements do not appear to offer any help to the general investor. While it is true that some studies have found that stock price reactions to earnings announcements are not always complete, whatever abnormalities exist do not occur consistently over time and have been small enough that only a professional broker-dealer would have earned abnormal profits.

Frank Stollery Parkette, 1 Davenport Road. Photo by Elena

Similarly, no new information is obtained from announcements of stock splits. While it is true that companies announcing stock splits have generally enjoyed rising stock prices in the period prior to the announcement of the splits, the relative performance of the stocks after the announcement turns out be precisely in line with that of the general market. The research indicates that splits are a consequence, not a cause, of rising stock prices and that no useful investment strategy can be undertaken on the basis of news of impending stock splits. These studies lend support to the old Wall Street maxim, “A pie doesn’t grow through its slicing.”

There has also been a good deal of research on the usefulness of dividend increases as a basis for selecting stocks that will give above-average performance. The argument is that an increase in a stock’s dividend is a signal by management that it anticipates strong future earnings. Dividend increases, inn fact, are usually an accurate indicator of increases in future earnings. There is also some tendency for a strong price performance to follow the dividend announcement. However, any rise in price resulting from the dividend increase, while perhaps not immediately reflected in the price of stock, was reflected reasonably completely by the end of the announcement month.

Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc.