The synergistic effect of direct and indirect methods in fundamental analysis: Evidence from Japan

ABSTRACT

We employ two types of firm valuation models, direct and indirect methods, to predict future stock returns and future earnings changes using a battery of variables from financial statements. We construct three investment strategies based on the valuation models and find significant abnormal returns by identifying overvalued and undervalued stocks. Furthermore, by holding the overlapping stocks between the two valuations models, we manage to construct a modified portfolio strategy that delivers the highest abnormal return, which demonstrates a synergistic effect between the two valuation methods.