Article2007

Sentiment and Financial Health Indicators for Value and Growth Stocks: The European Experience

53 citations0/0 files storedEuropean Journal of Finance

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Financial Markets and Investment Strategies Financial Analysis and Corporate Governance Financial Reporting and Valuation Research

Abstract

The well-documented market underperformance of the majority of value and growth stocks over a 12-month holding period reflects that traditional valuation metrics might tell us whether a stock is potentially cheap or expensive but little about when, or even if, it will experience a market correction. Two indicators have come to the fore in recent years that provide useful insights: sentiment/momentum and accounting fundamentals/financial health. We examine their single and combined impact on value and growth stocks and find that (i) they are effective in introducing a timing element into the selection of both value and growth stocks, (ii) the sentiment indicator completely dominates the financial health indicator and, (iii) both indictors contribute to the performance of the good and bad growth stocks. The size and significance of the investment profits that potentially can be generated using the two indicators in combination questions of the efficiency of the European equity markets. We conclude that our findings are consistent with the pricing cycle for a stock proposed by Lee and Swaminathan (Lee, C., Swaminathan, B. (2000) Lee, C. and Swaminathan, B. 2000. Price momentum and trading volume. Journal of Finance, 55: 2017–2069. [Crossref], [Web of Science ®] , [Google Scholar] Price momentum and trading volume, Journal of Finance, 55, pp. 2017–2069.) and the under- and over-reaction in pricing inherent in models proposed by Barberis et al. (Barberis, N., Shleifer A., and Vishny, R. (1998) Barberis, N., Shleifer, A. and Vishny, R. 1998. A model of investor sentiment. Journal of Financial Economics, 49: 307–343. [Crossref], [Web of Science ®] , [Google Scholar] A model of investor sentiment, Journal of Financial Economics, 49, pp. 307–343.) and Hong and Stein (Hong, H., Stein, J.C. (1999) Hong, H., Lim, T. and Stein, J. C. 1999. A unified theory of underreaction, momentum trading and overreaction in asset markets. Journal of Finance, 54: 2143–2184. [Crossref], [Web of Science ®] , [Google Scholar] A unified theory of underreaction, momentum trading and overreaction in asset markets, Journal of Finance, 54, pp. 2143-2184.).

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References

1993Common risk factors in the returns on stocks and bonds 1992The Cross-Section of Expected Stock Returns 1960The Application of Electronic Computers to Factor Analysis 1993Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency 1996Multifactor Explanations of Asset Pricing Anomalies 1994Contrarian Investment, Extrapolation, and Risk n.d.A model of investor sentiment /1999A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets

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