The Effectiveness of Fundamental Analysis on Value Stocks – an Analysis of Piotroski’s F-score

In an efficient market, assets reflect all available information. Hence, investors cannot earn abnormal returns by conducting fundamental analysis since all financial data is impounded in the asset. The only way for an investor to earn higher returns is by incurring increased risk. However, a growing body of evidence appears to contradict market efficiency and common notion of risk compensation. Piotroski (2000) documents that a fundamental investing strategy based on F-score applied on value stocks can generate abnormal returns. F-score is a scoring system aiming at identifying financially strong firms. This paper replicates Piotroski’s investment strategy on the US market for the period 2003-2015. My results show that a portfolio with high F-score earns a one-year market-adjusted return of 18.3 % annually. The corresponding return for a low F-score portfolio is 4 % annually. This significant mean return difference of 14.3 % indicates that fundamental analysis can be used to separate winner stocks from loser stock. The firms that document the highest returns are attributed with least financial distress, which contradicts the notion of risk compensation. The strongest benefit from the investment strategy is found in small and medium firms. The success of the investment strategy can be supported from a behavioral finance perspective. The findings suggest that limits to arbitrage may impede efficient pricing in small and medium firms. Moreover, value stocks are neglected by the investment community due to cognitive biases, and fundamental analysis can exploit this by finding financially strong performing firms in an unbiased fashion