Fundamental Analysis Conditioned On Firm Life Cycle: Mark Anderson Soonchul Hyun Dongning Yu

Fundamental Analysis Conditioned on Firm Life Cycle
Mark Anderson
Soonchul Hyun
Dongning Yu
University of Calgary
November, 2017
Abstract
Fundamental analysis is a technique that attempts to assess the value of corporate securities
by examining key value-drivers such as earnings, growth, and competitive position. It uses
information in financial statements to gain insights about a company’s future performance.
However, a signal used in fundamental analysis may have different implications for future
earnings under different circumstances. We use firm life cycle as a conditioning variable for
fundamental analysis, and investigate how the implications of fundamental signals for evaluating
firm performance vary according to life cycle stage. Using a sample of 81,613 firm-year
observations from 1989 to 2014, we find that fundamental signals based on accounts receivable,
capital expenditure, sales per employee, inventory, SG&A costs, and gross margin, are
differentially informative about firm value across firm life-cycle stages. We find that signals that
provide information about managers’ willingness to invest are particularly informative for intro-
stage firms and that signals related to operating performance and efficiency are particularly
informative for mature-stage firms. We also find that a simple trading strategy based on
fundamental signals and firm life cycle is effective in separating winners from losers in terms of
excess stock returns. Our findings provide insights about the use of accounting data in evaluating
firms.
Key words: fundamental analysis, firm life cycle, firm performance, financial statement analysis
I. Introduction
The question of how financial statements inform investors of firm equity value has been of
extensive research interest. Many researchers have addressed this question from the perspective
of the information content of accounting fundamentals (Brown 1993; Ou and Penman 1989; Lipe
1986; Ou 1990; Lev and Thiagarajan 1993; Fairfield et al. 1996; Nissim and Penman 2001;
Abaranell and Bushee 1997, 1998). According to Bauman (1996, p. 1), “fundamental analysis
involves inferring the value of a business firm’s equity without reference to the prices at which
the firm’s securities trade in the capital markets” and requires “an assessment of a firm’s
activities and prospects through published financial reports as well as other sources of
information concerning the firm, the product markets in which it competes, and the overall
economic environment.”
The theoretical basis for fundamental analysis comes from the informational perspective of
accounting that accounting data is relevant to equity valuation because it provides information
useful in estimating future dividends and predicting future earnings (Bauman 1996). Previous
studies have analytically and empirically investigated the value relevance of accounting
information provided in the financial statements. Lev and Thiagarjan (1993) suggest that
fundamental analysis is aimed at determining the value of corporate securities by a careful
examination of key value-drivers, such as earnings, risk, growth, and competitive position. They
identify a set of financial variables (fundamental signals) claimed by analysts to be useful in
security valuation and evaluate these claims by estimating the incremental value-relevance of
these variables over earnings. In addition, Abarbanell and Bushee (1997) investigate how
detailed financial statement data (fundamentals) enter the decisions of market participants by
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examining whether current changes in the fundamental signals are informative about subsequent
earnings changes.
Ou and Penman (1989) observed that textbooks of financial statements analysis describe
the calculation of financial statement ratios but provide scant prescription as to how these should
be used. Nissim and Penman (2001) further argued that many empirical studies have identified
accounting attributes driving value and documented robust correlations between these attributes
and market value, but this literature has not built a structure for identifying, analyzing and
summarizing financial statement information1 and has not produced a convincing model of
financial statement analysis for equity valuation. In addition, previous empirical studies have
typically employed a cross-sectional approach, using large samples of heterogeneous firms, and
have treated the accounting attributes as equivalently informative across firms and over time.
These research studies do not explicitly consider whether financial accounting attributes may
have differential value-relevance over the life span of a firm across different circumstances that
the firm may face.
It is commonly assumed that detailed financial statement data are useful for information
users when they make investment decisions. However, the informational value would be limited
if such information as earnings, risk, growth, and competitive position could not reflect diverse
aspects of companies. For example, differences in strategic activities across life-cycle stages of a
firm may result in different patterns among the firm’s financial statement components - earnings,
sales, expenses, cash flow, assets, and so on. Risk factors might also have different influences on
firm value depending on the life cycle of the firm.

1
Ou and Penman (1989) identify accounting attributes (ratios) that predict earnings changes in the data
using a statistical approach. On the other hand, Lev and Thiagarajan (1993) identify ratios that are used
by analysts, providing economic intuition to the identification of value-relevant information.
2
Anthoy and Ramesh (1992) suggest that performance measures differ across life cycle stages and find
2
Boston Consulting Group (1986) described changes in firms’ strategic positions, indicating
that a firm maximizes revenue growth early in its life to create permanent cost or demand
advantages over competitors, but in its mature stage market growth slows and investments are
less rewarding (Porter 1980). Many researchers in management, marketing, economics as well as
accounting have incorporated firm life cycle theory into their research (Spence 1979; Jovanovic
and Macdonald 1994; Anthony and Ramesh 1992; Parsons 1975; Wernerfelt 1985).
Firm life cycle theory is an extension of the product life cycle concept. As products move
through their life cycle stages (e.g., start-up, growth, mature, and decline), firms’ developmental
processes go through life cycle stages based on their portfolios of products (Muller 1972; Smith
et al. 1985). Dickinson (2011) observes the difficulty in assessing firm-level life-cycle stages
because they are a composite of many overlapping, but distinct, product life-cycle stages. She
develops a new approach to categorize firm-level life cycle based on the predicted behavior of
operating, investing, and financing cash flows across the different stages of the firm life cycle.
According to Dickinson (2011, p. 1969), “business firms are evolving entities, with the
path of evolution determined by internal factors (e.g., strategy choice, financial resources, and
managerial ability) and external factors (e.g., competitive environmental and macroeconomic
factors). Firm life cycles are made up of distinct phases that result from changes in these factors,
many of which arise from strategic activities undertaken by the firm.” Accounting information
reflects these different strategic activities, resulting in different implications for firm
performance2 and hence firm value across life-cycle stages. Thus, accounting information that is
capturing firms’ activities and accompanying profitability and risk would have different value-

2
Anthoy and Ramesh (1992) suggest that performance measures differ across life cycle stages and find
that stock market reactions to sales growth and capital expenditure are functions of life cycle stage
(unexpected positive sales growth and capital expenditure are most (least) valued by the capital market
during the firm’s growth (stagnant) stage.
3
relevance across life cycle stages. However, to our knowledge, no research on fundamental
analysis has incorporated life cycle theory in investigating how the accounting information is
valued in the market.
We argue that components of financial statements may have different economic
significance and may need to be interpreted as differentially value-relevant under different firm
circumstances (e.g., life cycle stages). We empirically examine whether and how financial
statement data (fundamentals) are differentially informative under different stages of firm life
cycle using signals from Abarbanell and Bushee (1998). We also compare the returns that would
be generated by applying a simple trading strategy based on fundamental signals within each
life-cycle category (Piotroski 2000). Using a sample of 81,613 firm-year observations from 1989
to 2014, we find that fundamental signals, based on accounts receivable, capital expenditure,
sales per employee, inventory, SG&A costs, and gross margin, are differentially informative for
firms in different life-cycle stages. We also find that a simple trading strategy based on signals
that are informative in each life-cycle stage is effective in separating winners from losers in
terms of one-year ahead excess stock returns.
Our findings indicate that the implications of signals in fundamental analysis for evaluating
firm performance vary across firm life-cycle stages, and provide insights about the usefulness of
accounting data in evaluating firms. Incorporating firm life cycle into financial statement
analysis would make it possible to consider the value-relevance of firms’ strategic activities
characterized by life-cycle stages. By providing a more comprehensive method for evaluating
firm performance, this approach may help investors and analysts to recognize risk factors that
differ across life-cycle stages and avoid mispricing firms.
4
In the next section, we review the literature on fundamental analysis and firm life cycle. In
Section III, we develop our hypotheses. In Section IV, we describe the sample data and
methodology. Section V presents the empirical results, and Section VI concludes by
summarizing our findings and discussing implications.
II. Literature review
Fundamental analysis
Fundamental analysis involves an examination of a firm’s activities and prospects based on
information in publicly available financial reports as well as other sources, and considers the
markets in which the firm competes and the overall economic environment (Bauman, 1996).
Previts et al. (1994) suggest that analysts “base their recommendations primarily on an
evaluation of company income … [and] commonly evaluate assets and liabilities on a cost, not
market-value basis” (p. 55). Findings by Lev and Thiagarajan (1993) and Abarbanell and Bushee
(1997) indicate that fundamental signals are value-relevant, and that analysts must search for
information from these signals in order to assess the value of a firm. Consistent with these
findings, Abarbanell and Bushee (1998) document that an investment strategy based on the
fundamental signals yields significant abnormal returns. In addition, Piotroski (2000)
demonstrates that a simple accounting-based fundamental analysis strategy, when applied to a
broad portfolio of high book-to-market firms, can shift the distribution of returns earned by an
investor. Investors can use information in financial statements to forecast earnings for the
reporting entity, estimate the risk of these earnings, and ultimately make an assessment of the
intrinsic value of the firm that can be compared to observed market prices (Richardon et al.
2010).
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Analysts generally attach a specific interpretation to a fundamental signal (e.g., a
disproportionate increase in inventory conveys bad news). However, interpretation of the
financial data in predicting corporate performance must be considered in light of the nature of a
company (Poston et al. 1994). In particular, Lev and Thiagarajan (1993) point out that a signal
used in fundamental analysis may have different implications for future earnings under different
circumstances. They examine fundamental signals used by financial analysts and find that, for
example, disproportionate increases in receivables and inventory are especially bad news for
investors in highly inflationary periods. Beneish et al. (2001) illustrate the usefulness of
contextual fundamental analysis for the prediction of extreme stock returns. Abarbanell and
Bushee (1997) suggest that the direction of firm-specific earnings news may affect the
interpretation of some signals.
Finding different implications of fundamental signals under different conditions highlights
the importance of performing conditioned fundamental analysis. Investors and analysts may
underutilize the information provided by fundamental signals if they do not consider how
fundamental signals may be differentially informative under different conditions.
Firm life cycle
Business firms are evolving entities whose fundamental economic decisions change over
their life cycles, and firm life-cycle stages have important implications for understanding the
financial performance of firms. The life-cycle concept identifies five stages in a firm’s life:
introduction, growth, maturity, shake-out and decline stage (Gort and Klepper 1982). At the
introduction stage, an innovation is first produced. The firm grows as the number of producers
increases. As the firm moves toward maturity, the number of producers reaches a maximum. As
6
the firm moves through the maturity stage, profitable investment opportunities diminish,
competition arises, and the market for the firm’s products begins to saturate. Consequently, the
firm will demonstrate lower growth rates (Mueller 1972; Grabowski and Mueller 1975). The
decline stage is typically characterized by falling sales and earnings and by increases in
unutilized production capacity.
The economics literature has addressed attributes of life cycle such as production behavior
(Spence 1977, 1979, 1981; Wernerfelt 1985; Jovanovic and MacDonald 1994), investment
(Spence 1977, 1979; Jovanovic 1982; Wernerfelt 1985), market entry and exit patterns (Caves
1998), and market share (Wernerfelt 1985) (see Dickinson 2011, p. 1970). In the accounting
literature, Richardson and Gordon (1980) suggest that different performance measures should be
used for different product life cycles because the critical tasks of manufacturing change as
products move through the life cycle. Anthony and Ramesh (1992) investigate the market
reaction to accounting performance measures in each life-cycle stage of the firm. They document
a declining stock market response to unexpected sales growth and unexpected capital investment
as the firm matures. Black (1998) examines the value-relevance of changes in operating,
investing, and financing cash flows by life-cycle stage and, in particular, documents that
investing cash flows are more value-relevant when firms are in the growth stage. Hribar and
Yehuda (2015) demonstrate that free cash flows and total accruals convey different information
at various stages of the firm’s development, by showing that the correlation between free cash
flows and total accruals is weakest in the growth stage and becomes stronger as the firm matures.
Dickinson (2011) developed and validated a firm-level life cycle proxy based on the
predicted behavior of operating, investing, and financing cash flows across different life-cycle
stages. This cash flow pattern proxy has advantages in that it uses the entire financial information
7
set contained in operating, investing, and financing cash flows rather than a single metric, such
as sales growth, capital expenditures, dividend payout, or age that are widely used in the
previous studies, to determine firm life cycle. Dickinson demonstrates that the cash flow pattern
proxy outperforms other life cycle proxies used in the literature (including age), and better
explains future profitability (both in rates of return and stock returns). This proxy for firm life-
cycle stages benefits information users by helping them to better understand how economic
fundamentals related to firm life cycle affect the level and convergence properties of future
profitability.
The firm life-cycle concept provides a setting for fundamental analysis because certain
signals may convey different information at different stages of the firm’s development (Hribar
and Yehuda 2015). Therefore, we perform conditioned fundamental analysis based on firm life
cycle to examine whether fundamental signals are differentially informative across different life-
cycle stages of the firm.
III. Hypothesis development
We follow Abarbanell and Bushee (1998) and identify seven fundamental signals: signals
based on capital expenditures, accounts receivable, sales per employee, inventory, gross margin,
SG&A expenses, and audit qualifications.3 The signals are defined such that their expected
relation with stock returns is positive under the traditional interpretation of the signals. We
further classify the signals into three categories that represent three aspects of the firm’s
condition: investment, operating performance, and reporting quality.

3
We don’t use earnings quality based on LIFO because it is no longer relevant. We exclude effective tax
rate because it constrains our sample.
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Signals: investment
Signals that we classify under the investment category reflect the firm’s willingness to
invest in capital and customers. Indications of managerial optimism may be more important and
more informative for firms in early life-cycle stages such as introduction and growth stages.
Capital expenditure (CAPX)
The capital expenditure signal is defined as the difference between the annual percentage
change in the firm’s capital expenditures and the percentage change in the corresponding two-
digit industry capital expenditures. A positive value of the signal (i.e., firm’s growth is larger
than the industry’s) implies good news based on managers’ optimism, and therefore a positive
relation with firm performance.
An increase in capital expenditure indicates investment in long-term assets (for example,
PP&E) to fund new projects, which implies that the firm has the confidence and financial ability
to invest in itself through capital expenditures. Anthony and Ramesh (1992) argue that a growing
firm is likely to have high capital expenditures, while a declining firm is likely to have low
capital expenditures. An increase in capital expenditure is especially good news for introduction
and growth firms as a result of managerial optimism and firms making early large investments to
deter entry (Jovanovic 1982; Spence 1977, 1979, 1981). However, for mature and decline firms,
an increase in firms’ capital expenditure may indicate imprudent investment in order to sustain
the investment level (Oler and Picconi 2014), and overinvestment may result in lower profits
because of excess capacity (Porter 1980; Lieberman 1987). In addition, Dickinson and Sommers
(2012) find that firms with the highest capital intensity relative to industry peers have lower
profitability, suggesting that there is a nonlinear relation between CAPX and future performance.
9
Therefore, it might be useful to condition the interpretation of the CAPX signal on firm life
cycle.
Accounts receivable (AR)
The accounts receivable signal is defined as the difference between the annual percentage
change in sales and the percentage change of accounts receivable. Under the traditional
interpretation, a positive value of the signal (i.e., sales’ growth is larger than that of accounts
receivable) indicates good news and a positive relation with firm performance. An increase in
accounts receivable suggests that the company has difficulties in selling its products (generally
triggering credit extensions), and there is an increasing likelihood of future earnings decreases
from increases in receivables’ provisions. In addition, an increase may indicate a higher
likelihood of earnings management, as unrealized revenues are recorded as sales.
In contrast, however, an increase in accounts receivable, especially for introduction and
growth firms, may suggest that managers are confident and that the company wisely
strengthened customer relationships by offering competitive, less restrictive payment terms.
Stickney and Weil (2006) argue that firm-level variables such as accounts receivables are likely
to vary over a firm’s life cycle. Accounts receivable are expected to be built up for a new, rapidly
growing firm. In this case, increases in accounts receivable may indicate that management
expands credit to increase sales and earnings (Abarbanell and Bushee 1997). Under this
alternative investment interpretation of the accounts receivable signal, the predicted sign is
negative. Based on the investment interpretations of these fundamental signals, we make the
following first hypothesis.
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HYPOTHESIS 1. To the extent that the capital expenditures (CAPX) and account
receivable (AR) signals provide information about managerial optimism, the
signals will be more informative for firms in early life-cycle stages.
Signals: operating performance
Signals under this category reflect information about the firm’s productivity, or efficiency in
selling, production, and cost control. As firms move to the mature stage, operating efficiency
becomes more important due to the higher number of competitors.
Sales per employee (SPE)
The sales per employee signal is defined as the annual percentage change in sales-per-
employee (the ratio of annual sales to the number of employees at year-end).
A positive value of the signal (i.e., an increase in sales-per-employee relative to prior year)
implies good news about labor productivity, and therefore a positive relation with firm
performance. Financial analysts generally comment favorably on announcements of corporate
restructuring, particularly labor force reductions. In the year of a significant labor force
reduction, wage-related expenses (e.g., severance pay) may increase but expected future labor
costs decrease. Reported earnings, in such cases, do not reflect the future benefits from
restructuring, and fundamentals such as the sales per employee signal are used to provide a better
assessment of future earnings (Lev and Thiagarajan 1993). A positive value of the signal
indicates higher efficiency of the employees in generating sales, which is more important and
informative for mature firms because of the critical role of efficiency.
Inventory (INV)
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The inventory signal is defined as the difference between the annual percentage change of
sales and the percentage change in inventory. A positive value of the signal (i.e., sales’ growth is
higher than inventory growth) indicates higher efficiency in generating sales from inventory, and
therefore good news and a positive relation with firm performance. Alternatively, sales’ growth
that is larger than inventory growth may be due to a drawdown of existing inventory, indicating a
reversal of prior inventory build ups. In this case, the inventory signal may be less informative.
Inventory increases suggest difficulty and inefficiency in generating sales, and earnings are
expected to decline as management attempts to lower inventory levels. A disproportionate
increase also suggests the existence of slow-moving or obsolete items that will be written off in
the future. In the introduction and growth stages, sales are expected to grow rapidly (Spence
1979). As firms mature, obsolescence increases (Jovanovic 1982), and the increase in inventory
indicates that obsolete items will be written off in the future and that sales are lower than
expected. Therefore, a disproportionate increase in inventory levels relative to sales provides
unfavorable signal for the firm’s future performance, especially for mature firms.
Gross margin (GM)
The gross margin signal is defined as the difference between the percentage change in gross
margin and that of sales. A positive value of the signal (i.e., sales’ growth is smaller than that of
gross margin) implies good news about product demand, and therefore a positive relation with
firm performance.
A higher gross margin is desirable as it suggests a greater potential for earning larger profits
and may indicate that the firm has been successful in differentiating its products from its peers.
Business with higher gross margin are better equipped against unanticipated increases in the cost
of production or competition. A decrease in gross margin is viewed negatively as poor sales
12
performance (declining demand) will typically lead to lower gross margins. Since efficiency is
maximized during the mature stage through increased knowledge of operations (Spence 1977,
1979, 1981; Wernerfelt 1985), a decrease in gross margin is especially bad news for mature
firms because such firms might have to lower prices due to declining growth rates (Wernerfelt
1985), increase in competition, and reduction in market share. Moreover, given the competitive
environment, an increase in gross margin is especially favorable for mature firms as expectations
for mature firms in terms of increasing gross margin are not as high as those for introduction and
growth firms.
SG&A expenses (SG&A)
The SG&A expenses signal is defined as the difference between the annual percentage
change in sales and the percentage change of SG&A expenses. A positive value of the signal
(i.e., sales’ growth is larger than that of SG&A expenses) implies good news, and therefore a
positive relation with firm performance.
A disproportionate (to sales) increase in SG&A expenses is considered as a negative signal
as the increase suggests inefficiency and inability of managers to control costs (Lev and
Thiagarajan 1993). Stickney and Weil (2006) argue that when a firm is no longer growing, it is
likely to report increased earnings associated with reductions in cost. Consequently, a reduction
in SG&A costs relative to sales may be a more favorable signal for mature firms than for
introduction and growth firms.
Based on the above arguments, we make the following hypothesis concerning operating
performance signals.
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HYPOTHESIS 2. Signals about operating performance, including the sales per
employee (SPE), inventory (INV), gross margin (GM), and SG&A signals are more
informative for mature firms than for firms in other stages.
Signal: reporting quality
The signal under this category reflects information about the quality of the firms’ financial
statements. The quality of financial information affects market valuation and also the cost of
capital (Healy and Palepu 2001; Francis et al. 2004; Lambert et al. 2007).
Audit Qualification (AQ)
The audit qualification signal is given a value of one if the auditor’s opinion is unqualified
with no additional language, and zero for other opinions.4 The signal with a value of one implies
good news about accounting quality, and therefore a positive relation with firm performance.
A qualified, disclaimed, or adverse audit opinion obviously sends a negative massage to
investors. Dopuch, Holthausen and Leftwich (1986) documented a significant negative stock
price reaction to qualified audit opinions. In addition, unqualified audit opinion with additional
language indicates increased financial misstatement risk (Czerney et al. 2014). Therefore, the
unqualified auditor report with no additional explanatory language indicates higher reporting
quality compared with unqualified audit opinion with additional language. Moreover, the audit
report is associated with firm specific characteristics (Bartov et al. 2001), such as firm life cycle.
The market may be more sensitive to information about accounting quality for firms in

4
Other opinions may include unqualified with additional language, unaudited, qualified, no opinion, and
adverse opinion in the Compustat data.
14
introduction and decline stages. Such firms are more fragile financially so indications of
accounting quality may have a greater impact on the capital market assessment of the firm.
This suggests that it is more valuable for firms in introduction and decline stages to receive
an unqualified audit opinion without additional language. We make the following hypothesis.
HYPOTHESIS 3. The signal of audit qualification (AQ) is more informative for firms
in introduction and decline stages.
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IV. Sample data and methodology
Sample data
We obtained the accounting data from COMPUSTAT annual files for North American firms
for the fiscal years from 1989 to 2014. We obtained stock return data to calculate excess returns
from the Centre for Research in Securities Prices (CRSP) monthly files for the fiscal years from
1989 to 2014.
We trimmed the data by eliminating firm-year observations that lied in the top and bottom
1% for each signal in our analysis (Lev and Thiagarajan 1993). We excluded observations in
which SG&A costs exceed sales (Anderson et al. 2007). We also excluded financial services
firms (SIC 6000-6999) because of differences in interpreting financial reports between these
industries and other industries (Subramanyam 1996), and because of the capital constraints that
materially alter their cash flow structure relative to other industries (Dickinson 2011). Our
sample contains 81,613 firm-year observations.
Methodology
Following Lev and Thiagarajan (1993), we relate excess stock return (R) to current earnings
change ( ∆ EPS), and other fundamentals, which are based on inventory (INV), accounts
receivable (AR), capital expenditure (CAPX), gross margin (GM), SG&A expenses (SG&A),
sales per employee (SPE), and audit qualification (AQ). Variable definitions are presented in
Table 1.
We first estimate a baseline regression for the full sample without incorporating firm life
cycle. We estimate the model in equation (1).
16
!
𝑅!" = 𝛼 + 𝛿! ∆𝐸𝑃𝑆!" + !!! 𝛾!" 𝑆𝑖𝑔𝑛𝑎𝑙𝑠!"# + 𝜀!"
(1)
where
𝑅!" = 12-month excess market-adjusted stock return (value-weighted market return as the
benchmark) of firm i, with the return accumulation starting with the fourth month after the end of
!"# !!"#
the fiscal year, and ∆𝐸𝑃𝑆!" = !"#$%!" !"#$%!"!! , which captures current earnings change.
!"!!
We then estimate equation (1) for each life-cycle stage (introduction, growth, mature, shake-
out, and decline) separately. Finally, we estimate the expanded model (2) with life-cycle
indicators. The expansions interact current earnings change and fundamental signals with
indicators of different life-cycle stages.
𝑅!" = 𝛼 + 𝐼𝑛𝑡𝑟𝑜 + 𝐺𝑟𝑜𝑤𝑡ℎ + 𝐷𝑒𝑐𝑙𝑖𝑛𝑒 + 𝑆ℎ𝑎𝑘𝑒𝑜𝑢𝑡 + !!!! 𝛾!" 𝑆𝑖𝑔𝑛𝑎𝑙𝑠!"# + 𝛿! ∆𝐸𝑃𝑆!" +

𝐼𝑛𝑡𝑟𝑜 !"!!! 𝛾!" 𝑆𝑖𝑔𝑛𝑎𝑙𝑠!"# + 𝛿! ∆𝐸𝑃𝑆!" + 𝐺𝑟𝑜𝑤𝑡ℎ
!"
!!!" 𝛾!" 𝑆𝑖𝑔𝑛𝑎𝑙𝑠!"# + 𝛿! ∆𝐸𝑃𝑆!" +
𝐷𝑒𝑐𝑙𝑖𝑛𝑒 !!!! 𝛾!! 𝑆𝑖𝑔𝑛𝑎𝑙𝑠!"# + 𝛿! ∆𝐸𝑃𝑆!" + 𝑆ℎ𝑎𝑘𝑒𝑜𝑢𝑡 !"
!"
!!!" 𝛾!" 𝑆𝑖𝑔𝑛𝑎𝑙𝑠!"# + 𝛿! ∆𝐸𝑃𝑆!" +
𝜀!"
(2)
where Intro, Growth, Decline, and Shakeout are indicators of firm life-cycle stages of
introduction, growth, decline, and shake-out, respectively. There is no indicator for mature stage
because this stage plays the base role in the expanded model.
To identify firm life cycles, we follow the life-cycle classification method developed by
Dickinson (2011). The firm life cycle proxy is based on patterns of cash flows from operating,
investing, and financing activities, and five theoretical life cycle stages (introduction, growth,
mature, shake-out, and decline) are identified. To identify the patterns of cash flow, we use the
total cash flow in each category for a three-year rolling window, which includes the previous two
years and the current year. This method provides a more stable measurement of the firm’s life-
cycle stage, since a three-year rolling window prevents unusual events from distorting a firm’s
17
cash flow patterns. Details of the classification can be found in Table 2.
We adopt a year-by-year regression approach, as in Lev and Thiagarajan (1993), Abarbanell
and Bushee (1997), and Anderson et al. (2007) to mitigate any potential biases induced by sales
changes clustering over time.
Descriptive statistics
Table 3 provides descriptive statistics. Descriptive statistics for the full sample are presented
in panel A of Table 3, and descriptive statistics for each life cycle stage are presented in panels B
to E of Table 3. Following Dickinson (2011), we omit the shake-out stage from our analysis
because there is no economic meaning associated with the shake-out stage. Consistent with
Dickinson (2011), there are many more firms in the growth and mature stages than in the
introduction and decline stages. Also, the firms in the introduction and decline stages are much
smaller on average than the firms in the growth and mature stages.
A comparison of the signals across the four stages is useful for setting the background for
our analysis. The capital expenditures signal that measures whether new CAPX is higher for the
firm than for its industry peers has a mean (median) value of 0.339 (-0.049) for introductory
firms, is slightly larger for growth firms (mean = 0.351, median = 0.100), is smaller for mature
firms (mean = 0.114, median = -0.020), and is negative for decline firms (mean = -0.046, median
= -0.326), consistent with high CAPX for early stage companies, moderate CAPX for mature
companies and low CAPX for decline stage companies. The accounts receivable signal that
measures whether sales are growing faster than receivables has a negative mean (median) value
of -0.158 (-0.080) for introduction firms and -0.129 (-0.070) for growth firms, is less negative for
mature firms (mean = -0.032, median = -0.014), and is negligible for decline firms (mean = -
18
0.009, median = 0.035). This pattern is consistent with high investment in customers for early
stage firms that are expanding their markets.
The sales per employee signal that measures whether the sales per employee are increasing
relative to prior year has a mean (median) value of 0.116 (0.069) for introduction firms, is lower
for growth firms (mean = 0.066, median = 0.045), is lower for mature firms (mean = 0.042,
median = 0.031), and is higher for decline firms (mean = 0.123, median = 0.071). This indicates
that sales are growing faster for introduction firms, and that the number of employees is
decreasing for decline firms. The inventory signal that measures whether sales are growing faster
than inventory has a mean (median) value of -0.129 (-0.074) for introduction-stage firms, is less
negative for growth firms (mean = -0.101, median = -0.061), is negligible for mature firms
(mean = -0.016, median = -0.006), and is somewhat positive for decline firms (mean = 0.044,
median = 0.058). This is consistent with high working capital requirements for early stage firms
that are developing their markets. The gross margin signal that measures whether sales are
growing faster than cost of goods sold has a mean (median) value of 0.142 (0.080) for
introduction firms and similar values for growth firms (mean = 0.124, median = 0.089). The
corresponding values for mature firms (mean = 0.039, median = 0.030) and for decline firms
(mean = 0.038, median = -0.008) are much lower, consistent with improvements in operating
efficiency during the early stages. The SG&A signal that measures whether sales are growing
faster than SG&A costs has an inverse pattern. The mean (median) values are -0.094 (-0.072) in
the introduction stage and -0.108 (-0.085) in the growth stage. They are relatively small in
magnitude (mean = -0.032, median = -0.030) in the mature stage and are positive in the decline
stage (mean = 0.070, median = 0.062). This pattern indicates that growth in SG&A costs leads
growth in sales in the early life-cycle stages.
19
The audit qualification signal that indicates whether the firm has an unqualified audit
opinion without additional language or not is relatively stable across different life-cycle stages. It
has a mean (median) of 0.718 (1) for introduction firms, 0.727 (1) for growth firms, 0.696 (1) for
mature firms, and 0.663 (1) for decline firms.5
Table 4 provides correlations among all the variables and signals used in the empirical
analysis. With the exception of capital expenditures and accounts receivable signals, all of the
signals are significantly and positively correlated with excess stock returns.
V. Empirical results
Regression results
Tables 5 provides estimation results of model (1) for the full sample and for five subsamples
of different life-cycle stages.
We observe that, for the full sample reported in column (1), the inventory, gross margin,
SG&A expenses, and audit qualification signals are all significantly and positively related to
excess stock returns. These results indicate that sales growth that is larger than growth of
inventory and SG&A expenses and is smaller than that of gross margin is favorable for firm’s
stock market performance, and that getting an unqualified audit opinion is also favorable. The
above findings are consistent with our expectations corresponding to the traditional interpretation
of these signals. The accounts receivable signal is significantly and negatively related to excess
stock return, indicating that sales growth that is lower than accounts receivable is good news for
firm performance. The negative sign supports an investment interpretation of this signal as an

5
Auditor’s opinion on a company’s financial statements includes unaudited, unqualified, qualified, no
opinion, unqualified with additional language, and adverse opinion in the Compustat data. Unqualified
opinion with no additional language accounts for about 70% of all opinions across life-cycle stages. Thus
about 30% of audit opinions are made up of the remaining five opinions.
20
indication of managers wisely extending credit to promote sales and earnings (Abarbanell and
Bushee 1997, 1998).
Columns (2) to (6) of Table 5 report results of estimating model (1) separately for five
different life-cycle stages. As noted above, the shake-out stage is not economically meaningful
under Dickinson’s (2011) approach. For the introduction stage, coefficients on all of the signals
are significant. The capital expenditure (𝛾 = 0.012, p < 0.10), inventory (𝛾 = 0.044, p < 0.05),
gross margin (𝛾 = 0.100, p < 0.01), SG&A expenses (𝛾 = 0.297, p < 0.01), and audit
qualification (𝛾 = 0.129, p < 0.01) signals are positively related to excess stock return as
expected, and the accounts receivable (𝛾 = -0.078, p < 0.01) and sales per employee (𝛾 = -0.097,
p < 0.05) signals are negatively related to excess stock return. Though we anticipate that the sales
per employee signal would provide more information for mature firms under the operating
performance interpretation, the negative sign on the sales per employee signal supports an
interpretation of the signal as an investment signal that reflects managerial optimism in the
expansion of the firm, or their unwillingness to lay off employees as they are optimistic and
anticipating future opportunities, and therefore an increase in the number of employees relative
to sales is actually considered as good news, especially for introduction firms that are seeking
growth and expansion. Therefore, we document that the sales per employee signal is informative
for introduction firms with regard to the investment perspective reflecting the firm’s willingness
to invest in labor.
For firms in the growth stage, the coefficients on the capital expenditure and sales per
employee signals are not significantly different from zero, but the coefficient on the accounts
receivable signal (𝛾 = -0.023, p < 0.05) remains significantly negative. For firms in the mature
stage, the accounts receivable signal is not significant. Finally, the inventory signal becomes
21
insignificant in the decline stage. The gross margin, SG&A expenses, and audit qualification
signals remain significant and positive across all life-cycle stages.
Table 6 provides estimation results of the expanded model (2) with life-cycle indicators.
Each signal is interacted with indicators of different life-cycle stages except for the mature stage,
because this stage plays the base role in the model. The results provide the same information as
the separate regression results in Table 5, but the coefficients indicate differences in the
informativeness of signals across the life-cycle stages. We observe that all the separate life-cycle
indicator variables (intercept terms) are significant, suggesting that life-cycle stage is an
important conditioning variable when analyzing fundamental signals.
The coefficient on the capital expenditures signal interacted with the indicator of the
introduction stage is significantly positive (𝛾 = 0.016, p < 0.10), indicating that growth in capital
expenditure of the firm that is larger than that of the industry is more informative and is more
favorable for firms in the introduction stage than in the mature stage. The coefficients on the
accounts receivable (𝛾 = -0.066, p < 0.05) and sales per employee (𝛾 = -0.145, p < 0.05) signals
interacted with the indicator for introduction stage are significantly negative, indicating that both
signals are more informative for firms in the introduction stage relative to the mature stage, if
these signals are interpreted as investment signals reflecting managerial optimism. In the
development of our hypotheses, we classified the sales to employee signal as an efficiency
measure, consistent with the traditional theory with respect to this signal. For introduction stage
firms, the results suggest that this signal may also be interpreted as an investment signal for early
stage firms. The results confirm that indications of managerial optimism are more important
from a valuation perspective for firms in early life-cycle stages than for firms in the mature
22
stage. This is consistent with Hypothesis 1 that the signals that convey information about
investment are more informative for firms in early stages.
The coefficients on the gross margin signal interacted with the indicators of introduction (𝛾
= -0.237, p < 0.01), growth (𝛾 = -0.110, p < 0.01), and decline (𝛾 = -0.198, p < 0.01) stages are
significantly negative, and the coefficient on the SG&A expenses signal interacted with the
indicator of growth stage (𝛾 = -0.060, p < 0.05) is also significantly negative. These results
indicate that increases in gross margin relative to sales and decreases in SG&A expenses relative
to sales are more informative for firms in the mature stage than for firms in other stages. Signals
under the operating performance category reflect information about the firm’s productivity, or
efficiency in selling, production, and cost control. The results confirm that as firms move to the
mature stage, changes in operating performance become more important and more informative
about firm performance. This is consistent with Hypothesis 2 that signals about operating
performance are more informative for mature firms than for firms in other stages, and it is
especially true for the gross margin signal.
For the audit qualification signal, which reflects information about the quality of the firms’
financial statements, the coefficients on this signal interacted with indicators of introduction (𝛾 =
0.092, p < 0.01) and decline (𝛾 = 0.078, p < 0.10) stages are significantly positive. These results
confirm that the market is more sensitive to information about accounting quality for firms in
introduction and decline stages and that it is more valuable for such firms to receive an
unqualified audit opinion.6 This is consistent with Hypothesis 3.

6
As noted above, the signal for audit qualification is coded as zero if the audit opinion is unqualified with
additional language, qualified, adverse, no opinion or unaudited. Unqualified with additional language
may include indication of going concern issues but the Compustat data does not identify this separately. If
such opinions are more prevalent for introduction and decline companies, this may partially explain the
stronger coefficient for these firms.
23
Taken together, the above results indicate that the fundamental signals are differentially
informative across different stages of firm life cycle, and that it is important to incorporate firm
life cycle into the analysis of fundamental information provided in the financial statement.
Robustness
Industry effects
To control for potential industry effects on stock return, we include industry dummies in
the estimation model. The results of the estimation are qualitatively similar with the results of the
main estimation. Table 7 presents the estimation results.
Size-adjusted excess returns
Firms in the introduction and decline stages are much smaller on average than firms in
the other stages. We use size-adjusted cumulative excess stock returns and present the results in
Table 8. We find similar results to those presented in Table 5 with two exceptions. The accounts
receivable signal is marginally significant and negative for the full sample but is not significant
for the introduction and growth stage firms as it was in Table 5. The sales per employee signal is
significantly positive for firms in the mature stage, consistent with the operating efficiency
interpretation of this variable for firms in the mature stage as predicted by hypothesis 2. The
negative sign on the sales per employee signal for introduction stage firms is retained, consistent
with the investment interpretation of this signal for introduction-stage firms.
Additional analysis: a simple trading strategy based on fundamental signals
In this part, we employ a simple trading strategy based on fundamental signals (Piotroski,
2000) and firm life cycle, and compare the returns that would be generated using all seven
24
signals with the returns that would be generated using those signals that were found to be
informative for each life-cycle stage. Based on the results reported above, we infer that there are
two different ways that changes in the signals have implications for firm performance. For the
first set of signals – CAPX, sales per employee (for mature firms), inventory, gross margin,
SG&A, and audit qualification signals, an increase in a signal provides positive information
about future stock returns. For the second set of signals – accounts receivable and sales per
employee (for introduction firms) signals, a decrease in a signal provides positive information
about future stock returns. Similar to Piotroski (2000), individual signal realizations are
independently assigned a score of zero or one. If a signal in the first set is positive, then the
indicator variable for this signal will be set equal to one, zero otherwise. If a signal in the second
set is positive, then the indicator variable for this signal will be set equal to zero, one otherwise.
An aggregated signal measure, F_SCORE, is defined as the sum of the binary signals.
We classify firms with the lowest aggregated scores as low F_SCORE firms and expect
these firms to have the worst subsequent stock performance. Alternatively, firms with the highest
scores are classified as high F_SCORE firms. These firms are expected to have the best
subsequent return performance. We compare the size-adjusted excess returns of high F_SCORE
firms with those of low F_SCORE firms and test whether the former outperforms the latter.
Table 9 presents the one-year size-adjusted excess stock returns to this simple fundamental
investment strategy. For the full sample in panel A, F_SCORE is the sum of all seven signals.
Firms with the lowest F_SCOREs (0 or 1) are classified as low F_SCORE firms and firms with
the highest F_SCOREs (6 or 7) are high F_SCORE firms. As documented in panel A, there is a
nearly monotonic positive relation between F_SCORE and excess returns. High F_SCORE firms
significantly outperform low F_SCORE firms in terms of one-year ahead size-adjusted excess
25
stock returns (0.070 versus -0.136). The mean return difference of 0.206 is significant at the 1%
level, suggesting that investors would earn a mean excess return of 20.6 percent if they took a
long position in high F_SCORE firms and a short position in low F_SCORE firms for the sample
as a whole. This result is similar to Piotroski’s (2000, p. 18) finding, where he documents a 23
percent difference between the high and low score firms in terms of one-year market-adjusted
returns.
Panel B presents results for firms in the introduction stage. In addition to the F_SCORE that
is comprised of all seven signals, a second F_SCORE that is comprised of the five signals (the
sales per employee, inventory, gross margin, SG&A, and audit qualification signals) that were
found to be significant for introduction firms in Table 7 is also calculated, where the low
F_SCORE firms have a F_SCORE of 0 and high F_SCORE firms have a F_SCORE of 5.7 For
all seven signals, the high F_SCORE introduction firms earn a mean excess return of 0.121
versus -0.189 for the low F_SCORE introduction firms. This difference of 0.310 is significant at
the 1% level. For the five significant signals, high F_SCORE introduction firms earn a mean
excess return of 0.086, and low F_SCORE firms earn a mean excess return of -0.343. The
difference of 0.429 is also significant at the 1% level, indicating a mean excess return of 42.9
percent if investors go long in high F_SCORE introduction firms and go short with the low
F_SCORE introduction firms. This excess return is appreciably higher than the 20.6 percent
excess return for the full sample and the 31.0 percent excess return for the introduction firms
based on seven signals.

7
This comparison is illustrative in nature and is not intended to be a rigorous comparison. To have
reasonably comparable numbers of observations for the low and high F_SCORE firms when we moved
from seven signals to five signals, it was necessary to limit the high F_SCORE firms to those with a score
of 5 and the low F_SCORE firms to those with a score of 0.
26
Results for firms in the growth stage are reported in panel C. For all seven signals, the
growth firms with a high F_SCORE have a mean excess return of 0.051, and those with a low
F_SCORE have a mean excess return of -0.159. The mean excess return difference is 0.210 and
is significant at the 1% level. For the four significant signals (Table 7), high F_SCORE (score =
4) growth firms earn a mean return of 0.148, and low F_SCORE (score = 0) firms earn a mean
return of -0.224. The difference of 0.372 is also significant at the 1% level, and is appreciably
higher than the mean difference of 0.210 for the growth firms based on seven signals. This is
consistent with the finding that five signals are informative for firms in the growth stage and
indicates that using all seven signals may add noise.
We find similar results for the mature firms in panel D. For all seven signals, the mature
firms with a high F_SCORE have a mean excess return of 0.081, and those with a low
F_SCORE have a mean excess return of -0.156. The mean excess return difference is 0.237 and
is significant at the 1% level. For the five signals that were found to be informative in the growth
stage, high F_SCORE (5) mature firms earn a mean excess return of 0.141, and low F_SCORE
(0) firms earn a mean excess return of -0.191. The difference of 0.332 is also significant at the
1% level, and is higher than the excess return difference of 0.237 obtained for the trading
strategy that uses seven signals. This indicates that using the five informative signals for mature
stage firms may be preferable to using all seven signals.
Finally, panel E presents results for firms in the decline stage. For all seven signals, the high
F_SCORE firms have a mean return of 0.364 versus -0.149 for low F_SCORE firms. The mean
return difference of 0.364 is significant at the 1% level. For the three significant signals, high
F_SCORE (3) decline firms earn a mean return of 0.178, and low F_SCORE (0) firms earn a
mean return of -0.152. The difference of 0.330 is significant at the 1% level. In this case, the
27
excess returns generated using seven signals are similar to those generated using the restricted set
of signals.
Overall, a simple trading strategy based on the significant fundamental signals in each life-
cycle stage is effective in separating winners from losers in terms of one-year ahead excess stock
returns. Fundamentally strong firms significantly outperform weak firms, and this pattern is
consistent across all of the life cycle stages. Interestingly, the strategy is much more effective in
picking losers versus winners for introduction firms (mean size-adjusted excess return of -0.343
for low F_SCORE firms versus mean return of 0.086 for high F_SCORE firms). It is also
somewhat more effective in picking losers than winners for growth and mature firms (mean
returns of -0.224 and -0.191 for low F_SCORE firms versus mean returns of 0.148 and 0.141 for
high F_SCORE firms). But it is slightly more effective in picking winners than losers for
decline firms (mean return of -0.152 for low F_SCORE firms versus mean return of 0.178 for
high F_SCORE firms).
VI. Conclusion
In this study, we use firm life cycle as a conditioning variable for fundamental analysis, and
investigate how the implications of fundamental signals in evaluating firm performance vary
across different life-cycle stages. We find that the magnitudes of the estimated effects of
fundamental signals on excess stock returns are significantly different across firm life cycles,
consistent with the premise that the signals are differentially informative for firms in different
life-cycle stages. Our analysis of excess returns generated using a simple trading strategy also
indicates that fundamental signals are differently informative across life-cycle states.
28
By using cash flow information to classify firms into life-cycle stages following Dickinson
(2011), our study extends the use of financial statements’ information in fundamental analysis to
include more information obtained from the statement of cash flow. But, rather than using cash
flow information to define specific signals, this approach uses cash flow information to condition
the interpretation of other signals. Our study also has implications for investors and analysts. If
they partition the signals according to different firm life cycle stages, investors and analysts may
be able to better utilize the information provided by fundamental signals and develop a more
thorough understanding of the firm’s financial position.
A limitation of our study is that we only use signals that have been identified in the previous
literature. Future research may identify other signals, both qualitative and quantitative, that
enhance the conditioned analysis. Further, fundamental analysis conducted by industry might be
useful. For instance, firms in some industries may have limited capital expenditures or accounts
receivable due to the nature of their business. Finally, our trading strategy that simply identifies
whether a signal is positive or negative does not necessarily use all of the information available
from the signals. A more complex algorithm could use the magnitudes of the signals.
29
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TABLE 1
Definition and measurement of variablesa
Variables (Signals) Measure

Excess Stock Returns (𝑅!,! ) 12-months cumulated excess stock return
EPS!,! − EPS!,!!!
Current Earnings Change ∆𝐸𝑃𝑆!,!
Stock Price!,!!!
Inventory (INV) ∆Sales "sale" − ∆Inventory "invt"
Accounts Receivable (AR) ∆Sales − ∆Accounts Receivable "rect"
Capital Expenditure (CAPX) ∆Firm CAPX "capx" − ∆Industry CAPXb
Gross Margin (GM) ∆Gross Margin "sale" − "cogs" − ∆Sales
SG&A Expenses (SG&A) ∆Sales − ∆SG&A Expenses "xsga"
!"#$%!,! !"#$%!,!!! !"#$%!,!!!
Sales per employee (SPE) −
#!"#$%&''((""#$")!,! #!"#$%&''(!,!!! #!"#$%&''(!,!!!
Audit Qualification (AQ) 1 for Unqualified, 0 for Qualified or other "auop"

a
Adapted from Abarbanell and Bushee (1998).
b
Industry capital expenditure is measured by aggregating this item for all firms at the two-digit SIC code level.
∆ refers to percentage annual change in the variable from the average of prior two years; e.g. ∆Sales = Sales! −
E Sales! /E(Sales! ), where E Sales! = (Sales!!! + Sales!!! )/2. The signals are defined such that their expected
relation with stock returns is positive.
34
TABLE 2
Classification of firm life cyclea
1 2 3 4 5 6 7 8
Introduction Growth Mature Shake- Shake- Shake- Decline Decline
Out Out Out
Predicted Sign
Cash flows
from operating − + + − + + − −
activities
Cash flows
from investing − − − − + + + +
activities
Cash flows
from financing + + − − + − + −
activities
a
Classification methodology is developed by Dickinson (2011, p. 1974) based on cash flow patterns from
operating, investing, and financing activities.
35
TABLE 3
Descriptive statistics
Panel A: Full sample (81,613)

Variables N Mean P10 P25 P50 P75 P90 S.D.
Sales 81,610 2,955.565 22.842 70.048 279.145 1,217.279 4,887.763 14,591.140
Inventory 80,946 289.217 0.000 2.415 19.482 114.682 504.000 1,323.541
Accounts Receivable 81,356 466.859 2.553 8.959 35.780 158.278 612.414 4,617.996
Capital Expenditures 80,903 209.284 0.457 2.086 11.303 61.100 285.725 1,267.161
Gross Margin 81,610 986.251 7.606 24.478 97.401 409.168 1,615.617 4,287.569
SG&A Expenses 81,610 520.068 5.982 16.579 57.914 223.395 847.098 2,246.958
# of Employees 79,853 10.780 0.115 0.349 1.403 6.000 22.100 44.142
Total Assets 81,610 3,417.955 20.292 64.672 277.181 1,285.559 5,266.445 17,717.650
Excess Stock Returns 77,877 0.050 -0.535 -0.243 0.013 0.291 0.645 0.551
∆EPS 80,394 0.015 -0.118 -0.029 0.004 0.034 0.138 0.223
Signals
Capital Expenditures 80,337 0.221 -0.638 -0.341 0.004 0.461 1.231 0.991
Accounts Receivable 80,587 -0.079 -0.465 -0.195 -0.033 0.104 0.277 0.384
Sales per Employee 78,614 0.063 -0.157 -0.046 0.039 0.135 0.290 0.224
Inventory 69,442 -0.055 -0.444 -0.184 -0.022 0.124 0.319 0.396
Gross Margin 81,490 0.082 -0.165 -0.040 0.049 0.162 0.361 0.322
SG&A Expenses 80,804 -0.062 -0.339 -0.159 -0.046 0.050 0.191 0.254
Audit Qualification 81,530 0.707 0.000 0.000 1.000 1.000 1.000 0.455
36
TABLE 3
Descriptive statistics (continued)
Panel B: Introduction (8,957)

Sales 8,957 377.774 8.606 20.388 57.637 175.025 555.096 2,335.629
Inventory 8,886 80.749 0.000 1.001 6.241 26.148 96.402 501.130
Accounts Receivable 8,916 54.960 1.065 3.032 9.658 29.487 90.463 327.733
Capital Expenditures 8,863 14.201 0.131 0.424 1.588 5.915 19.278 102.821
Gross Margin 8,957 83.388 2.532 6.346 18.418 53.574 146.008 410.130
SG&A Expenses 8,957 68.371 3.382 7.255 18.828 49.498 126.921 289.806
# of Employees 8,639 1.359 0.056 0.116 0.300 0.867 2.700 5.155
Total Assets 8,956 341.313 7.433 18.169 52.872 168.669 500.069 2,059.840
Excess Stock Returns 8,479 -0.017 -0.860 -0.478 -0.083 0.339 0.900 0.775
∆EPS 8,736 0.030 -0.227 -0.067 0.004 0.079 0.310 0.314
Signals
Capital Expenditures 8,784 0.339 -0.796 -0.525 -0.049 0.718 1.917 1.338
Inventory 7,623 -0.129 -0.753 -0.356 -0.074 0.170 0.451 0.541
Gross Margin 8,919 0.142 -0.290 -0.086 0.080 0.301 0.670 0.502
SG&A Expenses 8,850 -0.094 -0.555 -0.286 -0.072 0.112 0.327 0.370
37
TABLE 3
Panel C: Growth (31,580)

Sales 31,580 2,031.329 31.494 85.401 282.177 983.098 3,281.666 10,720.870
Inventory 31,237 213.568 0.000 1.679 17.224 94.300 349.779 1,078.879
Accounts Receivable 31,499 394.908 3.343 11.036 38.793 140.914 445.000 5,331.446
Gross Margin 31,580 626.554 11.346 31.936 103.449 337.055 1,052.650 2,899.621
SG&A Expenses 31,580 333.155 6.802 18.420 57.404 179.637 557.786 1,485.533
# of Employees 30,831 7.900 0.144 0.418 1.431 5.156 15.500 29.101
Total Assets 31,580 2,655.961 31.329 89.588 317.241 1,187.866 4,196.885 16,068.020
∆EPS 31,019 0.000 -0.110 -0.030 0.001 0.025 0.092 0.180
Signals
Capital Expenditures 31,077 0.351 -0.582 -0.276 0.100 0.631 1.499 1.066
Inventory 25,856 -0.101 -0.561 -0.253 -0.061 0.108 0.323 0.439
Gross Margin 31,540 0.124 -0.144 -0.013 0.089 0.223 0.432 0.335
SG&A Expenses 31,279 -0.108 -0.424 -0.221 -0.085 0.025 0.164 0.271
38
TABLE 3
Panel D: Mature (33,345)

Sales 33,345 4,859.647 38.076 131.725 567.824 2,401.728 9,294.300 19,700.340
Inventory 33,128 442.042 0.000 5.748 39.016 228.985 915.130 1,695.614
Accounts Receivable 33,253 654.206 3.761 14.206 63.583 289.656 1,163.000 3,371.966
Gross Margin 33,345 1,683.121 12.897 43.244 198.422 838.786 3,362.000 5,844.422
SG&A Expenses 33,345 868.270 8.196 25.192 106.013 453.112 1,736.636 3,070.457
# of Employees 32,858 17.152 0.187 0.672 2.800 11.200 39.199 61.173
Total Assets 33,343 5,248.910 29.626 105.372 490.676 2,289.633 9,917.400 20,458.930
∆EPS 33,000 0.013 -0.082 -0.021 0.004 0.027 0.099 0.189
Signals
Capital Expenditures 32,949 0.114 -0.568 -0.304 -0.020 0.318 0.851 0.771
Inventory 29,485 -0.016 -0.282 -0.120 -0.006 0.110 0.256 0.292
Gross Margin 33,341 0.039 -0.131 -0.038 0.030 0.099 0.203 0.207
SG&A Expenses 33,062 -0.032 -0.205 -0.103 -0.030 0.040 0.141 0.175
39
TABLE 3
Panel E: Decline (2,883)

Sales 2,880 467.906 7.737 18.415 48.757 151.586 453.711 3,741.205
Inventory 2,874 96.386 0.000 0.680 4.826 19.914 75.662 741.650
Accounts Receivable 2,859 68.215 1.022 2.738 8.034 24.308 67.821 584.179
Capital Expenditures 2,851 10.833 0.065 0.244 0.896 3.256 11.685 82.315
Gross Margin 2,880 110.045 2.302 6.177 16.538 50.188 147.540 584.524
SG&A Expenses 2,880 94.669 3.505 7.810 19.375 52.843 132.989 479.694
# of Employees 2,798 1.592 0.050 0.102 0.253 0.765 2.201 8.377
Total Assets 2,883 487.903 7.036 17.378 47.185 161.343 516.161 2,911.871
Excess Stock Returns 2,664 0.061 -0.742 -0.376 -0.025 0.387 0.951 0.784
∆EPS 2,850 0.098 -0.265 -0.069 0.029 0.203 0.586 0.402
Signals
Capital Expenditures 2,800 -0.046 -0.887 -0.664 -0.326 0.214 1.003 1.027
Accounts Receivable 2,828 -0.009 -0.472 -0.175 0.035 0.233 0.442 0.436
Inventory 2,410 0.044 -0.411 -0.156 0.058 0.283 0.541 0.445
Gross Margin 2,861 0.038 -0.347 -0.153 -0.008 0.160 0.473 0.456
SG&A Expenses 2,836 0.070 -0.270 -0.096 0.062 0.230 0.443 0.303
40
TABLE 4
Pearson correlation matrix
Excess
Variables Stock
(Signals) Return CAPX AR SPE INV GM SG&A AQ ∆EPS
Excess Stock
Return 1
CAPX -0.003 1
(0.469)
AR 0.005 -0.151 1
(0.190) (0.000)
SPE 0.040 0.026 0.122 1
(0.000) (0.000) (0.000)
INV 0.086 -0.130 0.209 0.211 1
(0.000) (0.000) (0.000) (0.000)
GM 0.081 0.181 -0.163 0.110 -0.074 1
(0.000) (0.000) (0.000) (0.000) (0.000)
SG&A 0.156 -0.121 0.174 0.239 0.248 -0.218 1
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
AQ 0.034 0.050 -0.043 -0.017 -0.029 0.053 -0.027 1
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
∆EPS 0.214 -0.030 0.048 0.090 0.100 0.125 0.234 0.005 1
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.164)
Numbers in parentheses are p-values.
41
TABLE 5
Regression results by life cycle
(1) Full
Variables (Signals) (2) Intro (3) Growth (4) Mature (5) Decline (6) Shake-Out
Sample
0.391*** 0.412*** 0.483*** 0.422*** 0.195*** 0.219***
∆EPS
(24.55) (9.81) (11.56) (11.77) (3.23) (2.89)
0.003 0.012* 0.005 -0.004 -0.008 -0.023
CAPX
(0.57) (1.87) (0.73) (-0.57) (-0.45) (-1.51)
-0.027*** -0.078*** -0.023** -0.013 0.001 -0.112***
Accounts Receivable
(-3.14) (-2.79) (-2.37) (-1.03) (0.03) (-2.69)
-0.029 -0.097** -0.021 0.048 -0.101 0.010
Sales per Employee
(-1.23) (-2.03) (-0.68) (1.38) (-1.29) (0.22)
0.055*** 0.044** 0.050*** 0.073*** 0.003 0.095**
Inventory
(6.16) (2.50) (4.22) (3.77) (0.04) (2.54)
0.200*** 0.100*** 0.227*** 0.336*** 0.139*** 0.281***
Gross Margin
(11.56) (4.21) (9.00) (9.38) (2.77) (4.85)
0.285*** 0.297*** 0.274*** 0.334*** 0.370*** 0.302***
SG&A
(14.20) (7.43) (11.55) (10.29) (3.58) (4.63)
0.067*** 0.129*** 0.064*** 0.037*** 0.115*** 0.045
Audit Qualification
(5.40) (5.13) (3.92) (4.22) (2.88) (1.37)
-0.005 -0.116** -0.008 0.032 -0.104 0.046
Intercept
(-0.18) (-2.39) (-0.28) (1.31) (-1.60) (1.15)
N 61,500 6,550 22,940 26,365 2,049 3,596

Avg. R2 0.090 0.130 0.104 0.120 0.188 0.172
Results are from year-by-year regressions computed based on Fama-MacBeth (1973) two-step procedure. The
coefficients and t-values are the average coefficients across years.
Numbers in parentheses are t-values.
*, **, *** indicate significance at the 10 percent, 5 percent, and 1 percent levels (two-tailed), respectively.
Dependent variable: Excess stock returns.
42
TABLE 6
Regression results with life cycle interactions
Variables Variables
Coefficients t-values Coefficients t-values
(Signals) (Signals)
Intercept 0.032 1.31 Decline (D) -0.136** -2.23
∆EPS 0.422*** 11.77 ∆EPS*D -0.0227*** -2.83
CAPX -0.004 -0.57 CAPX*D -0.004 -0.21
Accounts Receivable -0.013 -1.03 Accounts Receivable*D 0.014 0.22
Sales per Employee 0.048 1.38 Sales per Employee*D -0.149 -1.56
Inventory 0.073*** 3.77 Inventory*D -0.070 -0.97
Gross Margin 0.336*** 9.38 Gross Margin*D -0.198*** -3.05
SG&A 0.334*** 10.29 SG&A*D 0.036 0.30
Audit Qualification 0.037*** 4.22 Audit Qualification*D 0.078* 1.92
Introduction (I) -0.148*** -3.92 Shake-Out (S) 0.014 0.51

∆EPS*I -0.010 -0.19 ∆EPS*S -0.204** -2.01
CAPX*I 0.016* 1.90 CAPX*S -0.019 -1.27
Accounts Receivable*I -0.066** -2.09 Accounts Receivable*S -0.099** -2.26
Sales per Employee*I -0.145** -2.48 Sales per Employee*S -0.038 -0.64
Inventory*I -0.029 -1.26 Inventory*S 0.023 0.62
Gross Margin*I -0.237*** -6.03 Gross Margin*S -0.055 -0.94
SG&A*I -0.037 -0.71 SG&A*S -0.032 -0.55
Audit Qualification*I 0.092*** 3.35 Audit Qualification*S 0.008 0.27
Growth (G) -0.040*** -2.90 N 61,500

∆EPS*G 0.061 1.32 Avg. R2 0.144
CAPX*G 0.008 1.03
Accounts Receivable*G -0.011 -0.64
Sales per Employee*G -0.069 -1.57
Inventory*G 0.061 -1.06
Gross Margin*G -0.110*** -3.71
SG&A*G -0.060** -1.99
Audit Qualification*G 0.027* 1.76
Results are from year-by-year regressions computed based on Fama-MacBeth (1973) two-step procedure. The
coefficients and t-values are the average coefficients across years.
The mature stage is the reference group, meaning that the coefficients on the interaction terms represent the differences
in the average coefficients between the mature stage and each of the other life cycle stages.
43
TABLE 7
Regression results with industry fixed effect
(1) Full
Sample
0.373*** 0.392*** 0.463*** 0.405*** 0.235*** 0.445***
∆EPS
(25.08) (7.19) (10.92) (11.88) (3.05) (2.50)
0.003 0.015* 0.007 -0.005 -0.008 0.097
CAPX
(0.64) (1.81) (0.89) (-0.67) (-0.37) (0.80)
-0.025*** -0.084*** -0.024** -0.012 0.025 0.210
Accounts Receivable
(-2.89) (-3.06) (-2.25) (-1.01) (0.29) (0.73)
-0.028 -0.109** -0.018 0.055* -0.056 0.311
Sales per Employee
(-1.26) (-1.91) (-0.58) (1.77) (-0.51) (1.46)
0.048*** 0.055** 0.045*** 0.061*** -0.041 0.193
Inventory
(6.21) (2.30) (4.45) (3.29) (-0.59) (1.46)
0.193*** 0.086*** 0.215*** 0.322*** 0.017 0.444***
Gross Margin
(11.76) (3.22) (8.52) (9.48) (0.19) (2.84)
0.285*** 0.291*** 0.287*** 0.334*** 0.308*** 0.283***
SG&A
(17.30) (5.22) (12.07) (10.34) (2.53) (2.74)
0.059*** 0.108*** 0.050*** 0.029*** 0.109** 0.009
Audit Qualification
(5.47) (3.37) (4.25) (3.22) (2.09) (0.23)
-0.031 -0.027 -0.072 0.035 -0.216 -0.005
Intercept
(-1.10) (-0.27) (-1.21) (0.62) (-1.00) (-0.05)
N 61,500 6,550 22,940 26,365 2,049 3,596

Avg. Adjusted R2 0.131 0.103 0.146 0.166 0.090 0.149
Results are from year-by-year regressions computed based on Fama-MacBeth (1973) two-step procedure. The estimation model
includes industry fixed effect and considers robust adjustment of standard error by clustering industry. The coefficients and t-
values are the average across years.
44
Table 8
Regression results with size-adjusted excess stock returns
(1) Full
Sample
0.490*** 0.553*** 0.539*** 0.520*** 0.306*** 0.344***
∆EPS
(23.38) (9.39) (11.27) (12.47) (3.40) (4.50)
-0.002 -0.006 -0.000 -0.000 -0.040 -0.032**
CAPX
(-0.52) (-0.56) (-0.03) (-0.07) (-1.06) (-2.12)
-0.013* -0.025 -0.015 0.003 -0.154 -0.052
Accounts Receivable
(-1.77) (-1.05) (-1.39) (0.18) (-1.62) (-1.25)
0.001 -0.134** 0.006 0.080** -0.099 -0.007
Sales per Employee
(0.07) (-2.51) (0.18) (2.38) (-1.03) (-0.11)
0.062*** 0.074*** 0.056*** 0.084*** 0.118 0.108*
Inventory
(7.05) (3.97) (3.80) (4.89) (1.33) (1.94)
0.173*** 0.086*** 0.187*** 0.310*** 0.129* 0.187***
Gross Margin
(8.82) (3.31) (5.92) (7.22) (1.76) (3.37)
0.253*** 0.256*** 0.249*** 0.288*** 0.268* 0.221**
SG&A
(12.54) (4.70) (10.33) (8.82) (2.53) (2.73)
0.068*** 0.126*** 0.070*** 0.042*** 0.126** 0.060**
Audit Qualification
(6.74) (5.06) (4.71) (5.84) (2.19) (2.14)
-0.062*** -0.093** -0.073*** -0.048*** -0.074 -0.013
Intercept
(-5.12) (-2.74) (-4.75) (-3.78) (-1.53) (-0.41)
N 51,693 4,793 19,916 22,718 1,480 2,786

Avg. R2 0.093 0.1547 0.1021 0.1205 0.2418 0.1962
Results are from year-by-year regressions computed based on Fama-MacBeth (1973) two-step procedure.
The coefficients and t-values are the average coefficients across years.
Dependent variable: Size-adjusted excess stock returns.
45
TABLE 9
Returns to a fundamental analysis strategy
Panel A: Full Sample

Mean Median N
-0.022 -0.043 64,051
All Seven Signals

a
F_SCORE
0 -0.263 -0.257 186
1 -0.122 -0.138 1,618
2 -0.078 -0.087 6,790
3 -0.037 -0.058 14,225
4 -0.014 -0.035 16,486
5 0.013 -0.011 9,446
6 0.068 0.026 2,237
7 0.095 0.020 156
Low Score -0.136 -0.150 1,804
High Score 0.070 0.026
High-Lowb 0.206
t-statisticsc 15.012
(p-value) (0.000)
a
Each year, the individual signal realizations are independently ranked between zero and one. F_SCORE equals the
sum of the firm’s ranked realizations using all seven signals.
b
The High (Low) F_SCORE firm equals those with a F_SCORE of 6 and 7 (0 and 1).
c
t-statistics are based on two-tailed tests of the equality of means.
46
TABLE 9
Returns to a fundamental analysis strategy (continued)
Panel B: Introduction
Mean Median N Mean Median N
-0.040 -0.096 5,791
Five Significant Signals

All Seven Signals for Growth Firms
F_SCOREa
0 -0.424 -0.473 18 -0.343 -0.424 67
1 -0.164 -0.206 169 -0.199 -0.260 557
2 -0.157 -0.211 571 -0.082 -0.144 1,651
3 -0.049 -0.115 1,150 -0.020 -0.057 1,741
4 -0.048 -0.109 1,532 0.150 0.086 620
5 0.035 -0.006 926 0.086 0.023 64
6 0.121 0.015 203
7 0.112 0.197 15
Low Score -0.189 -0.212 187 -0.343 -0.424 67
High Score 0.121 0.018 218 0.086 0.023 64
High-Lowb 0.310 0.429

t-statisticsc 5.413 4.417
(p-value) (0.000) (0.000)
a
sum of the firm’s ranked realizations using all seven signals or only the five significant signals for introduction firms
(i.e., the sales per employee, inventory, gross margin, SG&A, and audit qualification signals).
b
The High (Low) F_SCORE firm equals those with a F_SCORE of 7 and 6 (0 and 1) when using all seven signals,
and equals those with a F_SCORE of 5 (0) when using the five significant signals.
c
47
TABLE 9
Panel C: Growth
-0.036 -0.050 25,944
Four Significant Signals

All Seven Signals for Growth Firms
F_SCOREa
0 -0.335 -0.349 65 -0.224 -0.234 540
1 -0.137 -0.169 508 -0.134 -0.128 4,217
2 -0.103 -0.112 2,311 -0.061 -0.065 9,400
3 -0.056 -0.071 5,359 0.032 0.007 5,591
4 -0.029 -0.043 6,576 0.148 0.099 1,212
5 -0.005 -0.018 3,983
6 0.048 0.024 915
7 0.109 0.104 53
Low Score -0.159 -0.177 573 -0.224 -0.234 540
High Score 0.051 0.027 968 0.148 0.099 1,212
High-Lowb 0.210 0.372

(p-value) (0.000) (0.000)
a
sum of the firm’s ranked realizations using all seven signals or only the four significant signals for growth firms
(i.e., the inventory, gross margin, SG&A, and audit qualification signals).
b
and equals those with a F_SCORE of 4 (0) when using the four significant signals.
c
48
TABLE 9
Panel D: Mature
-0.014 -0.035 27,061
Five Significant Signals

All Seven Signals for Mature Firms
F_SCOREa
0 -0.276 -0.236 89 -0.191 -0.185 393
1 -0.141 -0.149 752 -0.120 -0.127 2,395
2 -0.087 -0.101 2,468 -0.068 -0.076 6,117
3 -0.049 -0.063 5,335 -0.006 -0.026 7,888
4 -0.011 -0.029 6,855 0.059 0.021 5,212
5 0.033 0.004 5,031 0.141 0.095 1,206
6 0.076 0.036 1,831
7 0.113 0.078 301
Low Score -0.156 -0.155 841 -0.191 -0.185 393
High Score 0.081 0.042 2,132 0.141 0.095 1,206
High-Lowb 0.237 0.332

(p-value) (0.000) (0.000)
a
sum of the firm’s ranked realizations using all seven signals or only the five significant signals for mature firms (i.e.,
the sales per employee, inventory, gross margin, SG&A, and audit qualification signals).
b
and equals those with a F_SCORE of 5 (0) when using the five significant signals.
c
49
TABLE 9
Panel E: Decline
0.016 -0.035 1,765
Three Significant Signals

All Seven Signals For Decline Firms
F_SCOREa
0 -0.418 -0.465 6 -0.152 -0.160 106
1 -0.124 -0.141 65 -0.075 -0.127 494
2 -0.042 -0.091 234 0.026 -0.010 790
3 -0.025 -0.108 390 0.178 0.080 352
4 0.021 -0.032 389
5 0.068 0.005 235
6 0.230 0.139 65
7 0.055 0.046 6
Low Score -0.149 -0.151 71 -0.152 -0.160 106
High Score 0.215 0.123 71 0.178 0.080 352
High-Lowb 0.364 0.330

(p-value) (0.000) (0.000)
a
sum of the firm’s ranked realizations using all seven signals or only the three significant signals for mature firms
(i.e., the gross margin, SG&A, and SG&A signals).
b
and equals those with a F_SCORE of 3 (0) when using the three significant signals.
c
50

Fundamental Analysis Conditioned On Firm Life Cycle: Mark Anderson Soonchul Hyun Dongning Yu

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Fundamental Analysis Conditioned on Firm Life Cycle

fundamental analysis is aimed at determining the value of corporate securities by a careful

identify a set of financial variables (fundamental signals) claimed by analysts to be useful in

the firm may face.

firm value depending on the life cycle of the firm.

valued in the market.

We argue that components of financial statements may have different economic

terms of one-year ahead excess stock returns.

characterized by life-cycle stages. By providing a more comprehensive method for evaluating

differ across life-cycle stages and avoid mispricing firms.

methodology. Section V presents the empirical results, and Section VI concludes by

summarizing our findings and discussing implications.

II. Literature review

Fundamental analysis involves an examination of a firm’s activities and prospects based on

fundamental signals yields significant abnormal returns. In addition, Piotroski (2000)

demonstrates that a simple accounting-based fundamental analysis strategy, when applied to a

disproportionate increase in inventory conveys bad news). However, interpretation of the

interpretation of some signals.

Finding different implications of fundamental signals under different conditions highlights

fundamental signals may be differentially informative under different conditions.

Firm life cycle

unutilized production capacity.

cycle stages of the firm.

III. Hypothesis development

condition: investment, operating performance, and reporting quality.

Capital expenditure (CAPX)

relation with firm performance.

An increase in capital expenditure indicates investment in long-term assets (for example,

Accounts receivable (AR)

from increases in receivables’ provisions. In addition, an increase may indicate a higher

likelihood of earnings management, as unrealized revenues are recorded as sales.

In contrast, however, an increase in accounts receivable, especially for introduction and

strengthened customer relationships by offering competitive, less restrictive payment terms.

following first hypothesis.

receivable (AR) signals provide information about managerial optimism, the

signals will be more informative for firms in early life-cycle stages.

Signals: operating performance

becomes more important due to the higher number of competitors.

Sales per employee (SPE)

employee (the ratio of annual sales to the number of employees at year-end).

performance. Financial analysts generally comment favorably on announcements of corporate

informative for mature firms because of the critical role of efficiency.

expected to decline as management attempts to lower inventory levels. A disproportionate

expected. Therefore, a disproportionate increase in inventory levels relative to sales provides

Gross margin (GM)

of production or competition. A decrease in gross margin is viewed negatively as poor sales

SG&A expenses (SG&A)

positive relation with firm performance.

A disproportionate (to sales) increase in SG&A expenses is considered as a negative signal

introduction and growth firms.

informative for mature firms than for firms in other stages.

Signal: reporting quality

Audit Qualification (AQ)

A qualified, disclaimed, or adverse audit opinion obviously sends a negative massage to

in introduction and decline stages.

sample contains 81,613 firm-year observations.

cycle. We estimate the model in equation (1).

indicators of different life-cycle stages.

𝑅!" = 𝛼 + 𝐼𝑛𝑡𝑟𝑜 + 𝐺𝑟𝑜𝑤𝑡ℎ + 𝐷𝑒𝑐𝑙𝑖𝑛𝑒 + 𝑆ℎ𝑎𝑘𝑒𝑜𝑢𝑡 + !!!! 𝛾!" 𝑆𝑖𝑔𝑛𝑎𝑙𝑠!"# + 𝛿! ∆𝐸𝑃𝑆!" +

We adopt a year-by-year regression approach, as in Lev and Thiagarajan (1993), Abarbanell

changes clustering over time.

stage firms that are expanding their markets.