Stock Picking - Insights from academic research

Abstract

Despite the importance of the banking sector to the economy, prior valuation studies in accountinghave tended to generally discard bank stocks. We examine returns to a fundamental analysis based trading strategy for the U.S. bank stocks, using a bank fundamentals index (BSCORE) based on thirteen bank specific valuation signals. A long–short strategy based on BSCORE yields positive hedge returns for all but one year during the 1994–2013 period. Results are robust to partitions based on size, analyst following and exchange listing status, and persist after adjusting for known risk factors. Interestingly, we observe especially strong hedge returns during the 2007-2009 financial crisis. We further document a positive relation between BSCORE and future analystforecast surprises, earnings announcement period returns, and future performance-based delistings. Finally, the results are significantly enhanced if we combine the BSCORE strategy witha relative valuation strategy based on an intrinsic value approach. The results show that fundamental analysis can provide useful insights for analyzing banks, beyond the usual focus on metrics such as return on equity (ROE).