The prediction of Future Earnings using Fundamental Signals

Abstract: According to fundamental analysis theory, various sources of accounting and economic information may be used to determine the fundamental value of a firm. One such source is information included in the financial statements. Forecasting future earnings has been an objective of various previous studies within the fundamental analysis research field, due to its usefulness in the firm valuation process. Past research has shown that information found in financial statements can be used to predict future earnings. In our paper, we test whether results found in such previous studies hold true under more recent market conditions. Additionally, we test whether the effect of negative signals is stronger than the effect of positive signals. Our results show that the fundamental signals Inventory, Accounts Receivable and CAPEX are significantly related to future earnings, whereas no significant result was found for Gross Margin. We find that a positive signal change in Inventory has a larger effect on future earnings than a negative signal change. However, this asymmetrical effect was not observed for the remaining variables.