The high book-to-market investing strategy enhanced with fundamental analysis: Nordic evidence

Abstract

Prior studies show that companies with a high book-to-market (later BM) ratio provide better stock market performance compared to their low BM (later LBM) counterparts. Additionally, it is proved that fundamental signals provide relevant information for the prediction of future stock returns. The strategy utilized by Piotroski (2000) combines the information of the two branches of literature to select the winners and losers among high BM (later HBM) companies.

This paper studies whether the F-score, an aggregate of nine fundamental signals, proposed by Joseph Piotroski (2000) may be used in Nordic stock markets between 1978 and 2013 to increase the performance of a HBM portfolio. The companies are first ranked based on their BM ratios. Each year the highest quintile qualifies to the HBM group, which is ranked according to the Piotroski’s F-score method. A buy-and-hold portfolio is constructed annually in and every two years in May to evaluate the return prediction power of the F-score.

The results suggest that a investor buying the Nordic HBM stocks could increase average annual market-adjusted returns by 16 percent, and moreover, utilizing a strategy that buys the high F-score companies and takes a short position on the low F-score companies generates 57,9 percent market-adjusted returns annually. The F-score seems to be robust against other known return patterns as BM, size, accrual, equity offerings, and momentum. A post 2000 test of the strategy claims that the hedge portfolio manages to dodge the vast negative returns during the financial crises, but the high F-score portfolio produces more stable positive returns, as it is not dependent on the vigorous nature of the low F-score companies.