We outline a systematic approach to incorporate macroeconomic information into firm level forecasting from the perspective of an equity investor. Using a global sample of 198,315 firm-years over the 1998–2010 time period, we find that combining firm level exposures to countries (via geographic segment data) with forecasts of country level performance, is able to generate superior forecasts for firm fundamentals. This result is particularly evident for purely domestic firms. We further find that this forecasting benefit is associated with future excess stock returns. These relations are stronger after periods of higher dispersion in expected country level performance.

We survey recent research in accounting anomalies and fundamental analysis. We use forecasting of future earnings and returns as our organizing framework and suggest a roadmap for research aiming to document the forecasting benefits of accounting information. We combine this with opinions from the academic and practitioner communities to critically evaluate key clusters of papers about accounting anomalies and fundamental analysis disseminated over the last decade. Finally, we provide a new analysis on how an ex ante and ex post treatment of risk and transaction costs affects the accrual and PEAD anomalies, and offer suggestions for future research.

Deleveraging risk is the risk attributable to investing in a security held by levered investors. When there is an aggregate negative shock to the availability of funding capital, securities with a greater presence of levered investors experience extreme return realizations as these investors unwind their positions. Using data on equity loans as a proxy for the degree of levered positions in a given stock, we find robust evidence of deleveraging risk. Stocks with a high degree of short selling experience large positive returns and a decrease in short selling around periods of funding capital scarcity.

We develop a comprehensive and parsimonious measure of corporate financing activities and document a negative relation between this measure and both future stock returns and future profitability. The economic and statistical significance of our results is stronger than in previous research focusing on individual categories of corporate financing activities. To discriminate between risk versus misvaluation as explanations for this relation, we analyze the association between our measure of external financing and sell-side analysts’ forecasts. Consistent with the misvaluation explanation, our measure of external financing is positively related to overoptimism in analysts’ forecasts.

It has been alleged that firms and analysts engage in an "earnings‐guidance game" where analysts first issue optimistic earnings forecasts and then "walk down" their estimates to a level that firms can beat at the official earnings announcement. We examine whether the walk‐down to beatable targets is associated with managerial incentives to sell stock after earnings announcements on the firm's behalf (through new equity issuance) or from their personal accounts (through option exercises and stock sales). Consistent with these hypotheses, we find that the walk‐down to beatable targets is most pronounced when firms or insiders are net sellers of stock after an earnings announcement. These findings provide new insights on the impact of capital‐market incentives on communications between managers and analysts.

This paper lays out a decomposition of book‐to‐price (B/P) that derives from the accounting for book value and that articulates precisely how B/P “absorbs” leverage. The B/P ratio can be decomposed into an enterprise book‐to‐price (that pertains to operations and potentially reflects operating risk) and a leverage component (that reflects financing risk). The empirical analysis shows that the enterprise book‐to‐price ratio is positively related to subsequent stock returns but, conditional upon the enterprise book‐to‐price, the leverage component of B/P is negatively associated with future stock returns. Further, both enterprise book‐to‐price and leverage explain returns over those associated with Fama and French nominated factors—including the book‐to‐price factor—albeit negatively so for leverage. The seemingly perverse finding with respect to the leverage component of B/P survives under controls for size, estimated beta, return volatility, momentum, and default risk.

This paper extends the work of Sloan (1996. The Accounting Review 71, 289) by linking accrual reliability to earnings persistence. We construct a model showing that less reliable accruals lead to lower earnings persistence. We then develop a comprehensive balance sheet categorization of accruals and rate each category according to the reliability of the underlying accruals. Empirical tests generally confirm that less reliable accruals lead to lower earnings persistence and that investors do not fully anticipate the lower earnings persistence, leading to significant security mispricing. These results suggest that there are significant costs associated with incorporating less reliable accrual information in financial statements.

Prior research shows that the cash component of earnings is more persistent than the accrual component. We decompose the cash component into: (1) the change in the cash balance, (2) issuances/distributions to debt, and (3) issuances/distributions to equity. We find that the higher persistence of the cash component is entirely due to the subcomponent related to equity. The other subcomponents have persistence levels almost identical to accruals. We investigate whether investors understand the implications of the differential persistence of the three subcomponents. Our results suggest that investors correctly price debt and equity issuances/distributions but misprice the change in the cash balance in a similar manner to accruals. Our tests enable us to empirically distinguish the “accrual” and “external financing” anomalies with results implying that the accrual anomaly subsumes the external financing anomaly. Our results also suggest that naive fixation on earnings is unlikely to be a complete explanation for the accrual anomaly. Our findings are more consistent with investors misunderstanding diminishing returns to new investments.

Existing research indicates that firms with high accruals are more likely to experience future earnings problems, but that investors' expectations, as reflected in stock prices, do not appear to anticipate these problems. In this paper, we directly examine the published opinions of two types of professional investor intermediaries to see if they provide investors with information concerning the future earnings problems experienced by firms with high accruals. First, we examine the earnings forecasts of sell‐side analysts. We show that analysts' earnings forecasts do not incorporate the predictable future earnings declines associated with high accruals. Second, we examine the behavior of independent auditors. We find no evidence that auditors signal the future earnings problems associated with high accruals through either their audit opinions or through auditor changes. Overall, our evidence indicates that analysts and auditors do not alert investors to the future earnings problems associated with high accruals, thus corroborating previous findings that investors do not appear to anticipate these problems.