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Implementability of Trading Strategies Based on Accounting Information: Piotroski (2000) Revisited

Last Updated on 10 February, 2024 by Rejaul Karim

Sohyung Kim and Cheol Lee embark on a critical exploration of the practicality of trading strategies grounded in accounting information, particularly revisiting Piotroski’s seminal work in their paper, “Implementability of Trading Strategies Based on Accounting Information: Piotroski (2000) Revisited.”

They dissect the return accumulation approach prevalent in accounting-related anomaly studies, unveiling its impracticality in real-world application due to predetermined portfolio compositions before the real-time availability of accounting data. Through a meticulous re-examination of Piotroski’s fundamental signals, Kim and Lee unravel a nuanced relationship between these signals and subsequent returns, exposing the influence of return accumulation periods.

This revelation reverberates beyond Piotroski’s work, challenging prevailing methodologies in the accounting literature and suggesting potential overstatements of profitable trading strategies and market inefficiency in existing research.

Abstract Of Paper

The return accumulation approach used in studies on accounting-related anomalies cannot be replicated in a practical context because the number and identity of individual observations within a portfolio are assigned within a research context before the accounting information of all firms in the portfolio would actually be available in real time. We explore this issue by re-examining the results in Piotroski (2000) [Value investing: the use of historical financial statement information to separate winners from losers, Journal of Accounting Research, 38 (supplement), 1-44]. We find that the relationship between Piotroski’s fundamental signals and subsequent returns is partly driven by the choice of return accumulation periods. Because the method used in Piotroski is typical of those often employed in the accounting literature, this study suggests that evidence of profitable trading strategies and market inefficiency in the literature is likely to be overstated.

Original paper – Download PDF

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Author

Sohyung Kim
Brock University – Faculty of Business

Cheol Lee
Wayne State University

Conclusion

In conclusion, our revisit of Piotroski’s (2000) pioneering work on value investing, specifically focusing on the implementability of trading strategies based on accounting information, sheds light on critical considerations.

The conventional return accumulation approach, prevalent in accounting-related anomaly studies, faces practical challenges in real-time application due to its reliance on predetermined portfolio compositions. Our exploration reveals that the observed relationship between Piotroski’s fundamental signals and subsequent returns is, to some extent, influenced by the chosen return accumulation periods.

As this method mirrors prevalent practices in the accounting literature, our findings raise questions about the generalizability of evidence supporting profitable trading strategies and market inefficiencies. Caution is warranted in interpreting such results, emphasizing the need for a nuanced understanding of the dynamics at play in accounting-based investment strategies.

Related Reading:

An Emerging Markets Analysis of the Piotroski F Score

Twin Momentum: Fundamental Trends Matter

FAQ

Q1: What is the main issue addressed in the paper?

The paper addresses the implementability of trading strategies based on accounting information, specifically revisiting the work of Piotroski (2000). It dissects the return accumulation approach used in accounting-related anomaly studies, highlighting its impracticality in real-world application due to predetermined portfolio compositions before the real-time availability of accounting data. The authors explore this issue and re-examine the results in Piotroski’s work to shed light on the challenges associated with implementing such trading strategies.

Q2: What key findings do the authors present regarding Piotroski’s fundamental signals and subsequent returns?

The authors find that the relationship between Piotroski’s fundamental signals and subsequent returns is partly driven by the choice of return accumulation periods. The paper suggests that the conventional return accumulation approach, common in accounting literature, faces challenges in practical implementation due to its reliance on predetermined portfolio compositions. The findings question the generalizability of evidence supporting profitable trading strategies and market inefficiencies based on accounting information.

Q3: How does the paper contribute to the existing literature, and what implications does it have for trading strategy research in accounting?

The paper contributes by highlighting practical challenges in implementing trading strategies based on accounting information, particularly when using the return accumulation approach. The findings suggest that evidence of profitable trading strategies and market inefficiency in the literature, including Piotroski’s work, may be overstated. This has implications for researchers and practitioners, urging a more nuanced understanding of the dynamics involved in accounting-based investment strategies and caution in interpreting results from studies relying on predetermined portfolio compositions.

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