Frankel and Lee (1998)

Reference

Accounting Valuation, Market Expectation and Cross-Sectional Stock Returns^aaa

Richard Frankel and Charles M. C. Lee

The Journal of Accounting and Economics, Volume 25, (1998), 283-319.

Synopsis

This paper provides three useful refinements to the basic valuation strategies discussed in Lakonishok et al. First, it uses the residual income valuation model as a unifying framework for incorporating information in book value and earnings about intrinsic value. Second, it uses analysts' forecasts of earnings in addition to historical earnings. Third, it incorporates a model that adjusts for systematic biases in analysts' earnings forecasts (analysts tend to issue over-optimistic forecasts for growth firms). Each of these adjustments leads to an improvement over the basic valuation strategies. The annual hedge portfolio returns to a strategy that incorporates all of these refinements exceeds 10%.