Author
Abstract
Purpose - Frankel and Lee (1998) report significant abnormal security returns to a trading strategy based on the ratio of the intrinsic value to the market value of common equity (V/P). However, they measure the intrinsic value estimates based on the residual income model using several fundamental variables that have been documented to be associated with subsequent abnormal stock returns. The purpose of this paper is to test whether combining all these individual anomalies toV/Phas generated additional predictive power, and whether the abnormal returns related toV/Pare due to thepredictive ability of the residual income model or to that of the components used in constructingV/P. Design/methodology/approach - Two methods are used in this study to examineV/P's incremental effect. First, all the component variables ofV/Pare included in the same regression withV/Pto test whether the coefficient ofV/Premains significant. Second, an alternativeex antetransformation of the same component variables is developed and a test is conducted to see whether the trading profits based onV/Pand theex antetransformation differ. Findings - Overall, the paper finds thatV/Pdoes not provide additional explanatory power for subsequent abnormal returns over its component variables, especially analyst forecasts of earnings. The results imply that the source of the delayed security returns related toV/Pis the biases in investors' expectations regarding the constituent anomaly variables. Originality/value - This paper shows thatV/Pis not a distinct market anomaly. This finding is important to various stock market participants.
Suggested Citation
Le (Emily) Xu, 2007.
"IsV/Pa distinct anomaly?,"
Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 6(4), pages 404-418, November.
Handle:
RePEc:eme:rafpps:v:6:y:2007:i:4:p:404-418
DOI: 10.1108/14757700710835069
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