Deviations from Fundamentals in US and EU Stock Markets: A Comparative Analysis

Abstract

A 'two-stage growth' discounted cash flow (DCF) model is built to test whether changes in the underlying market fundamentals help to explain movements in stock prices. Empirical results on two samples of US and EU stocks show that the 'fundamental' earning price ratio (E/P) explains a significant share of cross-sectional variation of the observed E/P, this impact being stronger in the US market. It is also found that: (i) the fundamental component of the E/P has superior explanatory power than simpler measures of expected earnings growth; (ii) 'non-fundamental' components, interpreted as signals reducing asymmetric information (such as firm size, the number of forecasts and the chartist momentum), mitigate the role of the fundamentals; (iii) current deviations from the fundamentals are affected by ex post adjustment of publicly available information in the EU sample. It is argued that differences in regulatory environments and in the composition of investors between the US and EU financial systems may help to explain these comparative findings. Results appear consistent with the 'market integrity hypothesis' postulating that reliance on publicly observable fundamentals is higher when insider trading is lower.DCF fundamental value, price earning ratio, non-fundamental components, asymmetric information, insider trading,

Predicting returns with financial ratios: Evidence from Indonesian Stock Exchange

“…The study on stock prices is also interesting to be carried out by researchers in the fields of finance and investment. Several studies suggest that stock prices on the stock exchange are positively affected by changes in fundamental values, which include factors of profitability, growth, and dividends (Block, 1964;Shiller, 2001;Bodie et al, 2005;Lo & Lin, 2005;Becchetti & Di Giacomo, 2007). Das and Pattanayak (2013) introduced some interesting issues to the investors, managers, brokers as well as researchers to understand the importance of corporate fundamental factors in determining the share price movement and its effect on selection of stocks for designing an optimum portfolio.…”