Predicting high-tech stock returns with financial performance measures: Evidence from Taiwan

A one-year-ahead price change forecasting model is proposed based on the fundamental analysis to examine the relationship between equity market value and financial performance measures. By including book value and six financial statement items in the valuation model, current firm value can be determined and the estimation error can predict the direction and magnitude of future returns of a given portfolio. The six financial performance measures represent both cash flows – cash flows from operations (CFO), cash flows from investing (CFI), and cash flows from financing (CFF) – as well as net income – R&D expenditures (R&D), operating income (OI), and adjusted nonoperating income (ANOI). This study uses a 10-year sample of the Taiwan information electronic industry (1995–2004 with 2,465 firm-year observations). We find hedge portfolios (consisting of a long position in the most underpriced portfolio and an offsetting short position in the most overpriced portfolio) provide an average annual return of 43%, more than three times the average annual stock return of 12.6%. The result shows the estimation error can be a good stock return predictor; however, the return of hedge portfolios generally decreases as the market matures.