Implementability of Trading Strategies Based on Accounting Information: Piotroski (2000) Revisited

Abstract

The return accumulation approach used in studies on accounting-related anomalies cannot be replicated in a practical context because the number and identity of individual observations within a portfolio are assigned within a research context before the accounting information of all firms in the portfolio would actually be available in real time. We explore this issue by re-examining the results in Piotroski (2000) [Value investing: the use of historical financial statement information to separate winners from losers, Journal of Accounting Research, 38(supplement), 1−44]. We find that the relationship between Piotroski's fundamental signals and subsequent returns is partly driven by the choice of return accumulation periods. Because the method used in Piotroski is typical of those often employed in the accounting literature, this study suggests that evidence of profitable trading strategies and market inefficiency in the literature is likely to be overstated.

Acknowledgements

The authors greatly appreciate the advice from Gilles Hilary (editor), two anonymous referees, Sandra Chamberlain, Kai Li, Kin Lo, Russell Lundholm, Mort Pincus, Han Yi, and the participants at the 2012 Korea Academic Society of Business Administration annual meeting and the 2013 AAA annual meeting. This study is based on the second essay of Kim's dissertation at the University of British Columbia. Kim is grateful to members of his dissertation committee: Sandra Chamberlain (co-chair), Kin Lo (co-chair), and Kai Li for their guidance and direction.

Notes

¹It is worth noting that Piotroski is not the only study that is subject to the issue of trading strategy implementability raised in this study. However, there is an additional reason that makes revisiting Piotroski a worthy exercise. If the purpose of a study is to enhance the value investing strategy, then the methodology used in the study should be consistent with prior studies that document excess returns from value investing. Piotroski does not follow this general principle. Specifically, all three finance studies cited in Piotroski on value investing (Fama & French, 1992; Lakonishok, Shleifer, & Vishny, 1994; Rosenberg, Reid, & Lanstein, 1984) start accumulating returns of individual firms at a common date. In contrast, Piotroski accumulates returns starting four months after each firm's fiscal year-end. Thus, the question arises, would he have obtained similar results even if he had followed the approach used in these finance studies upon which he relied?

²See the Online Appendix for more details on Analysis 1 and Analysis 2.

³The Online Appendix outlines the variables and signals used in Piotroski to construct the F-Score.

⁴For example, assume the highest book-to-market quintile cutoff in year 2001 was 1.0 and the corresponding figure in year 2002 was 1.5. Then, firm-years with a book-to-market ratio that falls between 1.0 and 1.5 in year 2002 will only be included in Analysis 1. On the other hand, if the cutoff declined from 1.5 in year 2001 to 1.0 in year 2002, then firm-years with book-to-market ratio between 1.0 and 1.5 in year 2002 will only be included in Analysis 2.