Predicting stock returns from the pricing and mispricing of accounting fundamentals

This paper examines Nichols et al.’s (2017) fundamentals-based valuation model that links share prices to accounting fundamentals in European equity markets. The model explains, on average, 69 % of the cross-sectional share price variation among European firms. Deviations of share prices from the model’s fundamental value estimates hold unique information about subsequent stock returns that goes beyond established determinants of the cross-section. Firms identified as undervalued outperform firms perceived as overvalued by more than 0.54 % per month after controlling for firm size, book-to-market, operating profitability, investment, and momentum. Hence, the market seems to incorporate fundamental information only gradually