Returns from Financial Statement Analysis Among Low Book-to-Market Stocks : Evidence from India

The motivation behind this paper was to see if financial statement analysis could be employed by investors to design portfolios of low book-to-market stocks that could help them earn excess returns in the Indian context. Using a modified framework from Mohanram (2005), which employs a G_SCORE, capable of separating ex post winners from losers among low book-to-market companies, and portfolio formation on the basis of the G_SCORE, we find convincing evidence that financial statement analysis can help investors form profitable portfolios among low book-to-market stocks. We show that portfolios with high G_SCORE (6 to 7) provide outstanding returns both on absolute and risk-adjusted basis and far outperform the markets. At the same time, portfolios with low G_SCORE (0 to 3) offer very poor returns and always under-perform the markets on both absolute and risk-adjusted returns. Thus a growth investor could shift his distribution of returns rightwards by investing in portfolios of only high G_SCORE stocks; simultaneously shorting low G_SCORE portfolios would further amplify the returns