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Fundamental Strength and Short-Term Return Reversal

Last Updated on 10 February, 2024 by Rejaul Karim

The study “Fundamental Strength and Short-Term Return Reversal,” slated for publication in the Journal of Empirical Finance, uncovers the pivotal impact of a firm’s fundamental strength (FSCORE) on the dynamics of short-term reversal strategies.

Authored by Zhu, Sun, and Chen, the research highlights the compelling tendency of past underperforming stocks with robust fundamentals to outstrip past outperformers with weaker fundamentals, underscoring the profound influence of FSCORE on short-term performance.

Notably, the study’s FSCORE methodology emerges as a valuable complement to existing cash flow news metrics, particularly for firms lacking analyst coverage, and adept at capturing lagged effects from past fundamental news shocks.

Furthermore, the paper’s nuanced analysis vouches for the dominant role played by investor sentiment, surpassing liquidity shocks, in delineating return reversal dynamics, offering an insightful perspective into this intriguing phenomenon.

Abstract Of Paper

We document that the fundamental strength (FSCORE) of a firm exerts a significant influence on the performance of short-term reversal strategies. Past losers with strong fundamentals significantly outperform past winners with weak fundamentals. Our FSCORE approach is complementary to Da et al. (2014) cash flow news metrics based on analysts’ forecast revisions in that many firms do not have analyst following. Our approach also seems capable of capturing the lagged effects from past fundamental news shocks. After controlling for fundamental strength, we find that investor sentiment plays a more dominant role than do liquidity shocks in explaining return reversal.

Original paper – Download PDF

Here you can download the PDF and original paper of Fundamental Strength and Short-Term Return Reversal.

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Author

Zhaobo Zhu
Shenzhen University; Audencia Business School

Licheng Sun
Old Dominion University

Min Chen
San Francisco State University – Department of Accounting

Conclusion

The study “Fundamental Strength and Short-Term Return Reversal” puts forth compelling evidence to substantiate the profound impact of a firm’s fundamental strength (FSCORE) on short-term reversal strategies.

Authored by Zhu, Sun, and Chen, the research provides notable insights, showcasing the significant outperformance of past underperforming stocks with strong fundamentals in comparison to past winners with weaker fundamentals, underscoring the influential role of FSCORE in shaping short-term performance dynamics.

Moreover, the study’s FSCORE methodology emerges as a valuable complement to existing cash flow news metrics, particularly for firms lacking analyst coverage, effectively capturing lagged effects from past fundamental news shocks.

Furthermore, the research discerningly establishes the dominance of investor sentiment over liquidity shocks in delineating return reversal dynamics, culminating in a nuanced understanding of these intricate market dynamics.

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FAQ

What is the main finding of the study regarding the influence of a firm’s fundamental strength (FSCORE) on short-term reversal strategies?

The main finding of the study is that a firm’s fundamental strength (FSCORE) significantly influences the performance of short-term reversal strategies. Specifically, past underperforming stocks with strong fundamentals tend to outperform past winners with weak fundamentals. This underscores the pivotal role played by FSCORE in shaping the dynamics of short-term performance and return reversal.

How does the FSCORE approach introduced in the study complement existing cash flow news metrics, and why is it considered valuable, especially for firms lacking analyst coverage?

The FSCORE approach introduced in the study is considered complementary to existing cash flow news metrics, such as those based on analysts’ forecast revisions. The FSCORE methodology is particularly valuable for firms lacking analyst coverage, offering an alternative and effective way to assess fundamental strength. It serves as a valuable complement to existing metrics, providing insights into short-term reversal dynamics for a broader set of companies that may not have analyst following.

What does the study reveal about the relative importance of investor sentiment and liquidity shocks in explaining return reversal dynamics?

The study reveals that, after controlling for fundamental strength, investor sentiment plays a more dominant role than liquidity shocks in explaining return reversal dynamics. This finding suggests that the influence of investor sentiment surpasses that of liquidity shocks when it comes to shaping the short-term reversal patterns observed in the market. The research contributes to a nuanced understanding of the factors driving return reversal, highlighting the significance of investor sentiment in this context.

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