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AccountingResearchCenter,BoothSchoolofBusiness,UniversityofChicagoFundamentalInformationAnalysisAuthor(s):BaruchLevandS.RamuThiagarajanSource:JournalofAccountingResearch,Vol.31,No.2(Autumn,1993),pp.190-215Publishedby:BlackwellPublishingonbehalfofAccountingResearchCenter,BoothSchoolofBusiness,UniversityofChicagoStableURL::25/04/201100:26YouruseoftheJSTORarchiveindicatesyouracceptanceofJSTOR'sTermsandConditionsofUse,availableat.://=black..EachcopyofanypartofaJSTORtransmissionmustcontainthesamecopyrightnoticethatappearsonthescreenorprintedpageofsuchtransmission.JSTORisanot-for-profitservicethathelpsscholars,researchers,andstudentsdiscover,use,andbuilduponawiderangeofcontentinatrusteddigitalarchive.Weuseinformationtechnologyandtoolstoincreaseproductivityandfacilitatenewformsofscholarship.FormoreinformationaboutJSTOR,pleasecontactsupport@jstor.org.BlackwellPublishingandAccountingResearchCenter,BoothSchoolofBusiness,UniversityofChicagoarecollaboratingwithJSTORtodigitize,preserveandextendaccesstoJournalofAccountingResearch.*ANDS.RAMUTHIAGARAJANt1.IntroductionFundamentalanalysisisaimedatdeterminingthevalueofcorporatesecuritiesbyacarefulexaminationofkeyvalue-drivers,suchasearn-ings,risk,growth,andcompetitiveposition.Inthecontextofsuchanal-ysis,weidentifybelowasetoffinancialvariables(fundamentals)claimedbyanalyststobeusefulinsecurityvaluationandexaminetheseclaimsbyestimatingtheincrementalvalue-relevanceofthesevariablesoverearnings.Ourfindingssupporttheincrementalvalue-relevanceofmostoftheidentifiedfundamentals;infact,forthe1980s,thefundamentalsaddapproximately70%,onaverage,totheexplanatorypowerofearn-ingswithrespecttoexcessreturns.Wealsoshowthatthereturns-fun-damentalsrelationisconsiderablystrengthenedwhenitisconditionedonmacroeconomicvariables,therebydemonstratingtheimportanceofacontextualcapitalmarketanalysis.Forexample,severalfundamentalsthatappearonlyweaklyvalue-relevantorevenirrelevantintheuncon-ditionalanalysisexhibitstrongassociationwithreturnsunderspecificeconomicconditions(e.g.,theaccountsreceivableandtheprovisionfordoubtfulreceivablessignalsduringhighinflation).Fromageneralexaminationoftheroleoffundamentalsinsecurityvaluationweturntotherelatedissuesofearningspersistence,growth,andtheearningsresponsecoefficient.Wehypothesizethatthefunda-*Un7iversityofCalifornia,Berkeley;tNorthwesternUniversity.ThehelpfulcommentsofJefferyAbarbanell,RayBall,LindaBamber,BradBarber,MaiyBarth,WilliamBeaver,VictorBernard,GaiyBiddle,RobertBowen,NicholasDopuch,CatherineFinger,GeorgeFoster,RobertFreeman,RobertKaplan,CharlesLee,KrishnaPalepu,StephenPenman,K.Ramesh,TerryShevlin,ToshiShibano,D.Shores,AbbieSmith,JacobThomas,BrettTrueman,RossWatts,GregWaymire,RomanWeil,andPaulZarowinaregratefullyacknowledged.190Copyright?,InstituteofProfessionalAccounting1993FUNDAMENTALINFORMATIONANALYSIS191mentalsignalsidentifiedinthisstudyareusedbyinvestorstoassessthepersistence(sometimesreferredtoasquality)andgrowthofreportedearnings.Weprovidesupportforthishypothesisbydemonstratingasignificantrelationbetweenanaggregatescorereflectingtheinformationinthefundamentalsandtwoindicatorsofpersistence:theearningsre-sponsecoefficientandfutureearningsgrowth.Infact,thisfundamental(qualityofearnings)scoreismorestronglyassociatedwiththeresponsecoefficientthanatime-series-basedpersistencemeasure,suggestingthattheformerismoreeffectiveincapturingthepermanentcomponentofearningsthanthelatter,whichiscommonlyusedbyresearchers.Weidentifycandidatefundamentalstobeincludedintheempiricaltestsfromthewrittenpronouncementsoffinancialanalysts.Thisguidedsearchprocedureisdifferentfromthestatisticalsearchusedinpreviousresearch,suchasOuandPenman[1989].Adirectedsearchforfundamentals,guidedbytheoryorbyexperts'judgment,isanatu-ralextensionofthestatisticalsearchprocedure.1Thisstudythusextendsthesearchforvalue-relevantfundamentalsbothbyusingaguidedchoiceofcandidatevariablesandbycondition-ingthereturns-fundamentalsrelationonmacroeconomicvariables(acontextualanalysis).Wealsolinkourfundamentalanalysisfindingswiththepersistence/responsecoefficientliteraturebydemonstratingthattheidentifiedfundamentalscaptureimportantcharacteristicsofearningspersistence.2.TheSearchforFundamentalsToidentifyasetoffundamentalsusedtoevaluatefirms'performanceandestimatefutureearnings,wesearchedtheWallStreetJournalandBarron'sfor1984-90;2ValueLinepublicationsonqualityofearnings[1973a;1973b];professionalcommentariesoncorporatefinan