Valuing equity securities using fundamental analysis: Evidence from international stock markets

To date, there are many myths surrounding security selection and fundamental analysis due to the notion that all available information is perfectly priced in a security. However


Introduction
Undervalued stocks usually have a lower market price relative to some fundamental matrix like book value and earnings per share (Piotroski, 2000).Value premiums are the excess returns that value stocks generate over a given period of time (Ying, Tahir, Qurat, Yasmeen & Shahid, 2019).This excess returns date back to the 1980's and it is expected to continue provided that the appropriate stocks are selected.In other words, undervalued stocks are expected to spawn higher expected returns which was first documented by Rosenberg, Reid and Lanstein (1985) in a provocative paper titled persuasive evidence of market inefficiencies.
In Rosenberg et al., (1985) paper, they observed that low priced stocks relative to their fundamentals had persistent higher risk adjusted returns in a seemingly efficient market context.Later on, Fama and French (1992) empirically explored the risk adjusted returns for equity securities listed on the US markets and found that undervalued stocks produced a higher return relative to what the market will predict.This result was achieved by analysing a 28-year data set from 1963 to 1991.Over this period, Fama and French (1992) observed that undervalued stocks earned a large and statistically significant value premium of almost 4.9% per year on average.Fama and French (1992) then proposed that undervalued stocks were exposed to independent systematic risks separate from other categories of stocks.This led to the famous three factor model for asset pricing, including independent risk.In yet another paper, Fama and French (2000) also examined the value premium between US value stocks and the market from 1926 to 1963 which led to the conclusion that US value stocks produced a 2.39% return higher than the market.These reports provide compelling evidence of the existence of market inefficiencies and the relevance of selecting undervalued stocks for investment purposes (Enow, 2022).Therefore, investing in financial markets is predominantly a paradigm of valuation.It is also well documented (Suzana, Sinisa, & Zoran, 2013;Herawati & Putra, 2018;Sharma, Patil & Choudhari, 2021) that stock market valuations are a reflective mirage of fundamental value drivers such as price earnings ratio (PE ratio), earnings per share (EPS) and book-to-market (BTM) ratio.
In essence, the value of a stock market is most often facilitated through PE ratios, EPS and BTM ratios.Based on these measures, financial experts, professionals, and market participants can gain an intuitive understanding on the relative valuation for the stock market.The problem that has and will always be is to identify undervalued stocks relative to their overvalued counterparts.Therefore, the aim of this study was therefore to perform a valuation analysis using fundamental indicators on international stock markets around the world to highlight market buy or sell signals suitable for investment and portfolio management purposes.
Considering that investing in stock markets involves a considerable amount of risk, it is imperative to strive for undervalued stocks.Specifically, this study evaluates the following research questions; are there undervalued stock markets?This study does not only contribute to the literature of portfolio management and stock selection but also provides practical insight on stock market valuation hence a notable advancement.
The next section below highlights the theoretical underpinnings coined literature review followed by methodology and results and discussion and conclusion section.

Literature Review
Stock market valuation involves using standardised metrics that are perceived to have value to investors which drives future investment returns.Undervalued securities have historically produced an independent source of risk which has diversification benefits in portfolio management as well as risk management.Market research on US value premium stocks have been well documented in prior literature (Jeong, Lee & Mukherji, 2009;Athanassakos, 2009;Bevanda & Arnaut -Berilo, 2021) as well as evidence that anomalies in stock markets exist and tend to disappear or decline once they are published (Enow, 2022;Enow, 2023).Therefore, theorising observations on undervalued stocks that have outperformed other securities is not the core of financial theory and is really not helpful in isolation.These observations become helpful only when there is a strong theoretical explanation.A combination of empirical observations and theory allows financial experts to build predictions on the expected behaviour of financial markets.For example, there is no logical or theoretical explanation that stocks with letter A as the first letter which have outperformed the market for a 28-year period will continue to do the same for the next 28 years.
As Fama and French (1992) proposed, undervalued stocks tend to have higher returns because they are riskier and we would not expect to see value premiums disappear post their publications.Since finance theories demand that riskier investments should demand higher expected returns, there is a theoretical explanation for the existence of value premiums.These theoretical explanations mainly stem from the concept of market anomalies which refers to patterns or behaviours in financial markets that seem to deviate from what would be expected according to traditional financial theories, like the efficient market hypothesis.These anomalies can provide opportunities for investors to generate abnormal returns by exploiting the mispricing or inefficiencies (Enow, 2023).Some wellknown market anomalies include value Anomaly where stocks with lower price-to-earnings or price-to-book ratios tend to outperform those with higher ratios over the long term.This contradicts the efficient market hypothesis, which assumes that prices instantly reflect all available information.Also, momentum Anomaly suggests that stocks that have performed well in the recent past tend to continue performing well, while those that have performed poorly continue to perform poorly.Small-cap stocks have historically outperformed large-cap stocks over extended periods, which goes against the expected higher risk and volatility associated with smaller companies.Also, the risk and reward relationship and behavioural explanations for undervalued stock premiums have strong empirical support for market anomalies.From the risk perspective, stock markets with lower prices tend to be under distress, face substantial uncertainty in future earnings and have a higher financial leverage (Chen & Zheng, 1998).Furthermore, Zheng (2005) contends that undervalued stocks tend to be riskier than growth stocks during bad economic times which gives investors strong economic reasons to demand higher expected returns for taking on more risk.
With regards to valuation, a possible reason for mispricing value stocks was proposed by Piotroski and So (2012) who revealed systematic pricing errors in their valuation.The table below presents a summary of prior literature.The table above attempts to describe valuations based on certain fundamentals.From table 1, it is evident that fundamentals can be used for valuation as well as predict the future value of a security.Although relevant, there is still no study that has been conducted on fundamental analysis based on stock market valuation.Hence, this study extends the frontier of stock market valuation, which is a noteworthy contribution.The section below presents the valuation blueprints.

Methodology
A 2-stage blueprint was applied to achieve the objective of this study which is significantly different from prior literature.Firstly, the fundamental value drivers which were the stock price, Price Earnings ratios (PE ratio), Earnings per share (EPS) and book value (BV) were used to compute the Earnings yield (EY), PE ratio to price relative (PEP ratio) and Book to market price ratio (B/P).These value drivers have been well documented as the main variables of fundamental analysis (Piotroski & So, 2012;Bentes & Navas, 2013;Suzana, Sinisa, & Zoran, 2013;Tabot, 2022).An OLS regression analysis was then conducted to obtain the coefficients that were much needed in conducting a fundamental analysis.The regression equation is given by; Where  1 ,  2 ,  3 are the coefficients of the independent variables.These coefficients were used for the fair value estimates.These fair value estimates produced the buy or sell signals for the selected stock markets.The selected financial markets were the S&P 500, Nasdaq, the Johannesburg Stock Exchange (JSE), the Frankfurt stock exchange (DAX index), Japanese stock index (Nikkei 225), Borsa Istanbul 100 (BIST 100), London Stock Exchange (FTSE 100) and the Shanghai Stock Exchange (SSE).In terms of relevance, all the market data were obtained on January 23, 2023, from reputable financial market sources such as yahoo finance.The fundamental value drivers and daily market price where the main sources of data used in this study.These value drivers are factors that are perceived contribute to contribute to the overall performance of a stock.Therefore, identifying and focusing on the key value drivers for respective stocks can enhance the success of selecting undervalued securities.
The section below highlights the findings.

Results and Discussion
Tables 2, 3 and 4 presents the findings from the analysed data.These tables are used to presents important analyses.From table 2, the highest Earnings yields were recorded in the Nikkei 225 and BIST 100 which connotes that investors stand a good chance to receive a higher return than that of the risk-free asset.Also, the S&P 500, the DAX, Nikkei 225 and FTSE have the lowest PE value relative to the stock price.It is also evident that the book values from the DAX, Nikkei 225 and FTSE are relatively higher than the stock prices with the lowest in the Nasdaq and S&P 500.These matrices are important pieces of information that sheds light on the relative valuations.3 above presents the findings of the regression output.The R-square value is considerably high which infers that the fundamental value drivers provide a good explanation of the variability in stock prices (Piotroski & So, 2012;Bentes & Navas, 2013;Suzana, Sinisa, & Zoran, 2013;Tabot, 2022).There is also a significant positive relationship between the book value and stock price.
Although there is a positive relationship between the P/E ratio and stock prices, this relationship is insignificant.However, Earnings yield display an inverse relationship to stock price.By implication, these stock markets are attractive to investors seeking higher returns as the results present a summary of all the stock markets under consideration.Finally, the market signal findings are presented below.The value drivers for the S&P 500 backs up only 48% of the current stock price while the value generated from the fundamentals in the Nasdaq and BIST 100 and SSE are 84%, 70% and 87% respectively.However, the JSE, the DAX and Nikkei 225 and FTSE generates 106%, 121%, 117% and 116% value for their current stock prices.Accordingly, these higher valuation results consequently resulted in the JSE, the DAX and Nikkei 225 and FTSE being undervalued which in turn signal a "buy" order as highlighted in table 4. A higher security valuation can indicate positive investor sentiment, increased confidence in a company's prospects, and potential access to capital for expansion.However, it might also lead to higher expectations and pressure to deliver strong financial results.Additionally, it could result in a disconnect between the stock price and the company's actual performance, leading to concerns about a potential market bubble.On the contrary, the S&P 500, the Nasdaq, the BIST 100 and the SSE signal a "sell" order based on their value drivers.

Conclusion
The aim of this study was to conducted a fundamental analysis on 8 international stock markets using drivers such as EY, PEP ratio and B/P.Using a more recent data, the findings of this study indicates that the US stock markets are overvalued while the JSE, DAX, Nikkei 225 and FTSE 100 are undervalued and provides trading signals which are very useful for long term investors.Investors and market participants can make use of these trading signals to make informed decisions and potentially enhance their trading strategies.More specifically, these trading signals can help investors identify optimal entry and exit points for trades.For example, if a stock's price reaches a support level and an oversold "BUY" signal is present, it might be a good time to consider buying.The market signals highlighted in the previous section can help determine stop-loss levels or when to adjust your positions based on changing market conditions.If multiple signals align, it strengthens the conviction in the trend's potential continuation and investors can consider contrarian opportunities by buying when oversold and selling when overbought conditions are detected.The implication of this study is that JSE, DAX, Nikkei 225 and FTSE 100 offer strong growth potential when compared to the other stock markets.Also, value investors should assign more capital to these undervalued stock markets.Further studies should perform a sectorial valuation analysis for different markets.
Future research should use both a quantitative and qualitative methodology to value international stock markets.The qualitative aspect should be based on indicators such as industry analysis, a historical discussion of the earnings growth and an analysis on debt burden for the financial markets.

Table 1 :
Summary of Prior Literature on Fundamental Analysis

Table 2 :
Value Drivers Output

Table 3 :
Summary of Regression Analysis

Table 4 :
Market Signal from Value Drivers