Identifying investment strategies using accounting information from stock market

Abstract

Various profitability measures have been widely considered as the central measure of evaluation for the security analysis, bonds valuation and other credit and investment analysis in the financial markets (Ahmed et al., 2018; Belas et al., 2019; Dvorsky et al., 2019; Wang, Zhang, 2019). Contrasting to the predictive ability of earnings measure, there is also a perspective of accrual anomaly, which proposes that accruals are negatively correlated to the stock returns because of their low persistence in the earnings of the firm (Sloan, 1996; Ball et al., 2016; Kazemilari et al., 2018). Thus, we have attempted to present a case study and to evaluate whether the investment strategies including cash-based operating profits (cash OP), operating profits (OP) and accruals are pertinent in the Pakistan stock exchange (PSX). We report the impact of accruals is negative on stock returns, however, after controlling for small-sized firms despite having low accruals are not able to outperform high accrual firms. The hedge portfolios constructed by cash-based operating profits after controlling for size earn negative alphas for the three asset pricing models in the small-sized firms, however, these results reverse in the large-sized firms. Also, we can see a similar pattern in operating profitability. Thus, it can be concluded that the accruals, OP and cash OP offer a successful investment strategy for large-cap firms only.