The Value of a Two-Dimensional Value Investment

Strategy: Evidence from the Korean Stock Market

Seong-Soon Cho, Jung-Soon Shin, and Jinho Byun
ABSTRACT: This paper examines whether the two-dimensional value investment strategy
that incorporates both the value investment strategy and financial statement information
can earn excess returns in the Korean stock market. The two-dimensional value investment strategy yields a return of 27.9 percent, which is 8.97 percent higher than the
return provided by the simple value investment strategy. Thus, the result shows that the
two-dimensional strategy is not only effective in the U.S. stock market, but also effective
in emerging markets such as the Korean stock market. Furthermore, the two-dimensional
value investment strategy shows that the higher return during a bear market demonstrates
the strategys protective ability.
KEY WORDS: book-to-market ratio, FSCORE, glamor stocks, value investment, value stocks.

Investors have found that market anomaly, in contrast to market efficiency, can generate abnormal return, and various strategies incorporating this phenomenon have been
consistently developed.
The value investment strategy1 is one such strategy and consists of a long position in
value stocks and a short position in glamor stocks, using the valuation ratio to earn excess
return. Basu (1977, 1983) examined the validity of using earnings-to-price (EP) ratio to
assess the valuation ratios of firms. Subsequent studies have extended the variables to
evaluate a firms valuation to size, book-to-market (BM) ratio, and cash flow-to-price
(CP) ratio (Chan et al. 1991; Jaffe et al. 1989; Rosenberg et al. 1985) and to analyze the
reason for the excess returns earned by the value investment strategy (Fama and French
1992; Lakonishok et al. 1994; La Porta 1996; La Porta et al. 1997).
The two predominant theories of value premium are the risk compensation hypothesis
(Fama and French 1993) and the missed expectations hypothesis (Lakonishok et al. 1994).
Through the use of the book-to-market ratio, Fama and French explain that the excess
return on value stocks reflects compensation for a risk. Extending their 1993 results,
Fama and French (1995) analyze accounting earnings using both size and book-to-market
ratio, and obtain results consistent with rational pricing: a high book-to-market ratio
signals persistent poor earnings, and a low book-to-market ratio signals strong earnings.
Lakonishok et al. (1994), however, explain that the excess return on value stocks results
from the price correction of the initial mispricing: investors are overly optimistic (pessimistic) about the future performance of glamor (value) firms, and thus the expectation
errors cause a reversal in their returns.
Seong-Soon Cho (seongsoon.cho@gmail.com) is a Ph.D. candidate at the Ewha School of Business, Ewha Womans University, Korea. Jung-Soon Shin (shinjs@ewha.ac.kr) is an assistant professor of finance in the Ewha School of Business, Ewha Womans University, Korea. Jinho Byun
(jbyun@ewha.ac.kr), corresponding author, is an associate professor of finance in the Ewha School
of Business, Ewha Womans University, Korea. The authors thank two anonymous referees and
the editor, Ali M. Kutan, for their helpful comments. The authors also thank Sungtae Kim for his
excellent assistance.
Emerging Markets Finance & Trade / JulyAugust 2012, Vol. 48, Supplement 2, pp. 5881.
Copyright 2012 M.E. Sharpe, Inc. All rights reserved. Permissions: www.copyright.com
ISSN 1540-496X (print)/ISSN 1558-0938 (online)
DOI: 10.2753/REE1540-496X48S204

JulyAugust 2012 Supplement 59

Lakonishok et al. (1994) present the missed expectations hypothesis when examining the gap between the expected growth rate and the realized growth rate; however, the
article fails to provide a complete explanation for the missed expectations hypothesis.
In response, Piotroski (2000) suggests the usefulness of financial information to explain
the mispricing hypothesis and composes the FSCORE as a proxy for recent changes in
the financial performance of firms. Piotroski also claims that the excess returns provided
by the simple value investment strategy might be due to a few blue-chip firms and shows
that using the information from financial statements can increase the accuracy of the
strategy. In addition, Frankel and Lee (1998) use the earnings expectations of financial
analysts to separate value stocks from glamor stocks and show that such a value investment strategy generates positive return. This result confirms the usefulness of historical
financial statements.
Bartov and Kim (2004) measure the performance of two-dimensional value investment
strategies using additional accounting accruals as financial information to find expectation errors in the value investment strategy. They find that annual returns on a strategy
of investing in mispriced portfolios formed by buying stocks with high book-to-market
ratio and low accruals and selling stocks with low book-to-market ratio and high accruals outperform those on the book-to-market classification or the accruals classification
alone, with no evidence of increased risk.
Piotroski and So (2011) also argue that a two-dimensional investment strategy that
incorporates financial statement analysis and value ratios generates higher returns than
a one-dimensional investment strategy that consists only of value ratio. Based on their
studies, this paper examines whether various simple value ratios and the composite value
(CV) ratio also apply to the Korean stock market and analyzes the validity of the twodimensional value investment strategy using FSCORE.
Previous studies have mostly dealt with developed markets; few have focused on
emerging markets, including the Korean market. In the case of emerging markets, the
stock price may only partially reflect financial information because earnings reports or
disclosures may be less accurate and the markets regulatory system may be less developed.
For example, Wang and Xie (2010) find evidence of overreaction and the profitability
of a contrarian strategy on the Chinese stock market; Lai et al. (2010) show the asymmetric market responses to technical buy and sell signals on the Taiwan stock market;
and Kim and Byun (2010) provide evidence that investor sentiment have the power to
predict the buy-and-hold returns on the Korean stock market. In addition, the limited
role of institutional investors in emerging markets might generate a chance of getting
abnormal returns from using financial information. Specifically in Korea, the proportion of
individual investors trading volume in 2010 was about 92 percent (64 percent in trading
amount). Bartov and Kim (2004) indicate that mispricing may be more prominent in the
stocks of unsophisticated investors. Because individual investors use financial information
less frequently than institutional investors do, it would be a useful investment strategy to
use missed expectations on stock pricing in order to obtain abnormal returns in Korean
markets, in which there is a heavy amount of trading done by individual investors. In
addition, by showing the varying results of value investment strategies according to
market conditions, this paper will demonstrate how strategies can be applied differently
according to such conditions. In order to examine whether the abnormal returns of twodimensional strategy comes from reward-to-risk or expectation errors, we employed the
FamaFrench three-factor and four-factor models, with turnover as the liquidity factor,
and still found that the two-dimensional value investment strategy was valid.

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Emerging Markets Finance & Trade

Some studies on the Korean stock market suggested the presence of a value premium
(Chang and Kim 2003; Gam 1999; Kim and Lee 2006; Song 1999). This paper generalizes the effectiveness of the value investment strategy by expanding the sample period to
recent years. Chang and Kim (2003) also analyzed the validity of the two-dimensional
value investment strategy using financial conditions. However, they concentrated on
profitability data such as gross margin rate, return on invested capital, and interest coverage ratio to measure financial conditions, and thus failed to use the financial statement
holistically. This paper makes use of FSCORE, which measures not only a firms profitability, but also the changes in financial leverage and liquidity, and changing operational
efficiency. Unlike previous studies, in which abnormal return calculations were based
on a market index, this study, like that of Piotroski and So (2011), uses size, which is a
market anomaly, to measure the effect of value investments more accurately. By using
a size-adjusted portfolio when calculating abnormal returns, this paper supplements the
shortcomings of previous studies.
The result shows that a value premium also exists in the Korean stock market. In
particular, a one-dimensional investment strategy using composite value (CV) yields an
18.93 percent return, which is higher than the return from any other one-dimensional
value investment strategy using individual value ratios. This indicates that using various
proxies for relative value is more effective than utilizing a single valuation proxy in an
investment strategy. Moreover, a two-dimensional value investment strategy that incorporates information from financial statements and value ratios generates higher returns
than a one-dimensional value investment strategy does. Buying value stocks with good
financial conditions and selling glamor stocks with bad financial conditions can generate
at most a 27.9 percent, size-adjusted buy-and-hold abnormal return, which is 8.97 percent
higher than the return from a one-dimensional value investment strategy. As Piotroski
and So (2011) showed, this study shows that the value effect resides in portfolios with
high expectation errors.
A comparison of the returns during bear and bull markets using value investment
strategies revealed that a value premium exists in both conditions. In addition, consistent
with the results of the full sample, in both bear and bull markets the two-dimensional
value investment strategy generates a higher return than does the one-dimensional value
investment strategy. Furthermore, this paper shows that both one-dimensional and twodimensional value investment strategies generate higher profits during the downturn of
the stock market, proving their protective ability. In bear markets, the two-dimensional
value investment strategy using share turnover has higher returns than that which involves
using the composite value, a fact that implies that liquidity is important in the bear market
condition. After controlling for liquidity in our multivariate analysis, we find additional
returns from the two-dimensional value investment strategy.
Research Design
Value/Glamor Classification
Like Piotroski and So (2011), we use a multidimensional approach and a composite
approach to classify value stocks and glamor stocks. Proxies such as book-to-market
(BM), earnings-to-price (EP), cash-flow-to-price (CP), sales growth (SG), and equity
share turnover (ST) are used for relative value. Among these values, BM, EP, and CP are
based on the stock price to identify value stocks and glamor stocks. In other words, since

JulyAugust 2012 Supplement 61

pricing multiples provide information about firms with prices that do not fully reflect
their fundamental values, higher values of BM, EP, and CP indicate deep value stocks.
On the contrary, lower values of SG and ST indicate deep value stocks.
BM is calculated by dividing the total equity at the end of the fiscal year2 t 1 by
the market capitalization at the end of the fiscal year t 1. EP is calculated by dividing
the net income per share by adjusted stock price at the end of the fiscal year t 1. CP
is calculated by dividing cash flow per share by adjusted stock price at the end of the
fiscal year t 1. SG is calculated by dividing the difference between sales at year t 1
and year t 2 by the sales at year t 2. ST is calculated by adjusting the average daily
trading volume from July of year t 1 (the year before the portfolio formation) until the
end of June of year t to the average number of shares.
To formulate a value/glamor stock portfolio every year, each dimension of relative
values is divided into the top 30 percent, the middle 40 percent, and the bottom 30 percent.
Firms in the top 30 percent and bottom 30 percent are value stocks (glamor stocks if low
SG and ST) and glamor stocks (value stocks if high SG and ST), respectively.
The average of the decile rank of each value proxy is used to calculate the composite
measure of values, or CV. However, the decile ranks of SG and ST are multiplied by 1
because their values are reversed.
CV =

Decile ( BM ) + Decile (CP ) + Decile ( EP ) + Decile (SG ) + Decile (ST )

5

Korean Stock Market Liquidity and K-IFRS

The liquidity of the Korean stock market is relatively high because the proportion of individual investors who tend to frequently trade is high. According to the Korean Digital Times,
in 2011 the share turnover of the Korea Stock Exchange ranked at third in the world after
the Nasdaq OMX and the Shenzhen Stock Exchange in China. Measuring liquidity, we
use the turnover ratio, which is the trading volume adjusted to the number of outstanding
shares, as has been done in previous studies (Brennan and Subrahmanyam 1995; Chordia et
al. 2001; Rouwenhorst 1999). We included a liquidity variable as a risk factor in our fourfactor model to measure risk-adjusted returns based on Yun et al. (2009), who show that
liquidity has more explanatory power than book-to-market ratio in Korea. Kim and Byun
(2011) present a summary of behavioral finance literature in the Korean market.
At the end of 2007, the Korean International Financial Reporting Standards (K-IFRS)
were released. The K-IFRS are a word-for-word translation of the full IFRS issued by the
International Accounting Standards Board (IASB) and have been mandatory for Korean
listed companies with assets over 2 trillion won since 2011 (voluntary early adoption
became possible in 2009 for all companies except financial institutions). However, companies with assets of less than 2 trillion won are allowed to keep their current accounting
systems until 2013.
One of the main changes incurred by introducing IFRS is that unlike K-GAAP, K-IFRS
generally use historical cost, but intangible assets, property, plant, and equipment (PPE),
and investment property may be revalued to fair value. Derivatives and certain other
financial instruments and biological assets are also revalued to fair value. Because of
these changes, if revaluation engenders profits, companies can expect a decrease in liabilities. Therefore, companies owning many fine tangible assets are expected to benefit
from adopting IFRS, which will make their books more attractive.

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Emerging Markets Finance & Trade

FSCORE Classification
Like Piotroski (2000), we compose the FSCORE to classify firms based on the recent
financial performance trend. The FSCORE is the sum of nine financial signals: four
variables measure profitability, three measure change in financial leverage/liquidity, and
two measure change in operational efficiency. Signal realization is divided into good and
bad implications for future profitability and cash flow. An indicator variable with good
signal realization equals 1, and an indicator variable with bad signal realization equals
0. The FSCORE measures the overall financial condition of a firm.
Out of the nine signals, return on assets (ROA), cash flow from operations (CFO),
change in net income ($NI), and ACCRUAL look into a firms profitability. ROA is
calculated as net income during year t scaled by total assets at the beginning of the year.
The indicator variable F_ROA receives one point if ROA is positive and zero points if it
is negative. CFO is calculated as cash flow from operations during year t scaled by total
assets at the beginning of the year. The indicator variable F_CFO receives one point if
CFO is greater than 0 and zero points if it is less than 0. $NI, change in net income, is
calculated as the current years net income minus the prior years net income realization.
The indicator variable F_$NI receives one point if $NI is positive, and zero points if it is
negative. ACCRUAL is calculated as the current years net income minus cash flow from
operations, scaled by average total assets. The indicator variable F_ACCRUAL receives
one point if ACCRUAL is lower than 0 and zero points if it is higher than 0.
The following variables are designed to measure the firms capital structure and ability
to pay future debt service obligations. Change in long-term leverage ($LEVER) is the
change in the ratio of long-term debt to total assets. The indicator variable F_$LEVER
receives one point if LEVER decreases and zero points if it increases. A high leverage
ratio indicates a firms high financial risk. Change in current ratio ($LIQUID) is the ratio
of current assets to current liabilities at the end of a fiscal year compared to the prior years
ratio. The indicator variable F_$LIQUID receives one point if LIQUID increases and zero
points if it decreases. ISSUANCE checks if a firm is raising external equity capital. The
indicator variable F_ISSUANCE receives zero points if a firms change in capital stock
is positive between year t and year t 1, and one point otherwise. A firm raising external
equity capital displays its inability to raise internal capital to pay for future debts. As
explained in Piotroski (2000), external debt and equity issuance are possible responses to
a positive NPV (net present value) investment opportunity, but prior empirical research
proves that such events negatively affect a firms stock price.3
The last two signals measure a firms operating efficiency. Change in the gross margin
($MARGIN) is the difference between a firms current gross margin ratio and the previous
years. Since a positive change in the gross margin ratio signals a firms improved condition,
the indicator variable F_$MARGIN receives one point if $MARGIN is positive and zero
points if it is negative. Change in asset turnover ($TURN) is calculated as the firms current
asset turnover ratio minus the prior years asset turnover ratio. Asset turnover is defined as
total sales scaled by average total assets. The indicator variable F_$TURN receives one
point if $TURN is positive and zero points if it is negative. An increase in a firms turnover
ratio indicates a firms efficiency in generating more sales revenue with its assets.
The FSCORE, which measures a firms recent financial performance, is calculated
by adding up the points of the nine individual signals, with a score ranging from zero to
nine. A high FSCORE indicates a firm with strong recent financial performance, and a
low FSCORE indicates a firm with weak recent financial performance.

JulyAugust 2012 Supplement 63

FSCORE = F_ROA + F_CFO + F_$NI + F_ACCRUAL + F_$LEVER

+ F_$LIQUID + F_ISSUANCE + F_$MARGIN + F_$TURN.
We will conduct an empirical analysis to see whether FSCORE can identify expectation errors in value firms and glamor firms more precisely.
Two-Dimensional Value Investment Strategy
The fact that less than 44 percent of high book-to-market firms earn positive returns for
two consecutive years supports the presence of heterogeneity even within a value portfolio (Piotroski 2000). Thus, this paper tests if including both valuation ratio and financial
fundamentals in the portfolio generates greater returns than using a one-dimensional
investment strategy does.
This studys two-dimensional value investment strategy is based upon the characteristics of CV and FSCORE, which are calculated according to the method of Piotroski
and So (2011). If the prices of glamor firms demonstrate overly optimistic expectations
and prices of value firms demonstrate overly pessimistic expectations, the value/glamor
strategy should identify overvalued firms in the glamor portfolio and undervalued firms
in the value portfolio. The FSCORE should be able to accurately identify firms with significant expectation errors within the value/glamor portfolios. If the FSCORE does not
point in the same direction as the value dimension, there will be significant expectation
errors. Expectation errors should mainly appear in firms whose fundamentals as reflected
in the FSCORE differ the most from those reflected in the value ratios.
According to the mispricing hypothesis, expectation errors should be more significant
in value firms with a high FSCORE and glamor firms with a low FSCORE, as shown
in Figure 1. The incongruent investment strategy, using two portfolios with significant
expectation errors, consists of a long position in value firms with a high FSCORE and
a short position in glamor firms with a low FSCORE. This strategy means that long the
portfolio with a high potential for being undervalued and short the portfolio with a high
potential for being overvalued. As a result, the highest return can be expected using an
incongruent investment strategy when a price reversal occurs to correct the expectation
error. Inversely, the congruent investment strategy, using two diagonal portfolios with
small expectation errors, consists of a long position in value firms with a low FSCORE
and a short position in glamor firms with a high FSCORE.
Size Benchmark Portfolio Formation and Calculations of
Abnormal Returns
We present annual, size-adjusted, equally weighted buy-and-hold returns for most of our
results. To adjust for size, following Fama and French (1992), we construct a size decile
benchmark portfolio during the portfolio formation time by using all the stocks (except
those of financial firms) listed on the Korea Composite Stock Price Index (KOSPI) market.
Each year, we reconstruct a benchmark portfolio using market capitalization at the end
of June in year t. Assuming an annual buy-and-hold strategy, the annual size-adjusted
equally weighted buy-and-hold return on a firm is computed as the return on that firm
minus the buy-and-hold return on the size benchmark portfolio.
If the firm delists prior to the end of the twelve-month compounding period, the delisting return is replaced by the average return of the size benchmark portfolio.

64

Emerging Markets Finance & Trade

Low CV Firms

High CV Firms

Glamor

Value

High Potential for

Overvalued Firms

Low Potential for

Undervalued Firms

Significant Expectation
Errors

Small Expectation
Errors

Low Potential for

Overvalued Firms

High Potential for

Undervalued Firms

Small Expectation
Errors

Significant Expectation
Errors

Low FSCORE

High FSCORE

Figure 1. Value/glamor and FSCORE matrix

Notes: Firms with high potential for overvaluation and undervaluation are concentrated in off-diagonal
portfolios that have significant expectation errors. But firms with low potential for overvaluation and
undervaluation are concentrated in diagonal portfolios that have small expectation errors.

Results
Data
The research period for this paper is from January 1981 to June 2011. The sample consists
of companies listed on the KOSPI market4 with a December fiscal year-end; it excludes
firms from the finance industry. Since the two previous years of financial statements are
required, the financial statements from 1981 to 2009 are used in the formation of the
portfolio for the investment strategy. Portfolio performance is based on the returns for
twenty-seven years, from July 1984 to June 2011. The sample includes 11,810 firm-years.
Financial statements and stock information used to compose the FSCORE and calculate
the value ratio are taken from FnGuide (Korean financial database).
Table 1 represents descriptive statistics of the five CV and nine FSCORE components.
With the exception of change in gross margin ($MARGIN) and change in asset turnover
($TURN), all FSCORE components have positive indicators of more than 50 percent.
One-Dimensional Investment Strategy: Value Investment Strategy
Table 2 represents the annual size-adjusted buy-and-hold returns of the simple value
investment strategy. The value investment strategy consists of a long position in value
firms and a short position in glamor firms. When using the valuation ratios, all but sales
growth (SG) prove the existence of a value premium (significant at the 1 percent level).
These results are congruent with previous research and signify that a value premium
exists in the Korean stock market.
Specifically, among the investment strategies that utilize individual valuation proxies,
the investment strategy using cash-flow-to-price (CP) generates a 15.06 percent annual
buy-and-hold return, and the strategy using share turnover (ST) generates the highest
annual buy-and-hold return: 18.64 percent. However, the value investment strategy using CV, which is composed of five individual valuation ratios, earns an 18.93 percent

0.16
4.68
2.71
0.57
0.00
0.31
0.29
232,403
0.31
0.29
2.23
15,667
0.17
0.82

0.03
0.05
2,449
0.02
0.01
0.03
3,111
0.00
0.03

Min

1.71
0.19
0.63
0.11
0.01

Mean

Note: Variables are winsorized at the top and bottom 1 percent.

CV components
BM (book-to-market)
EP (earnings-to-price)
CP (cash-flow-to-price)
SG (sales growth)
ST (share turnover)
FSCORE components
ROA
CFO
NI (million KRW)
ACCRUAL
LEVER
C_LIQUID
ISSUANCE (million KRW)
MARGIN
TURN

Items

0.01
0.01
2,153
0.08
0.04
0.17

0.02
0.12

0.75
0.01
0.06
-0.01
0.00

25th
percentile

0.03
0.05
175
0.02
0.00
0.00

0.00
0.02

1.22
0.08
0.19
0.09
0.01

Median

Table 1. Descriptive statistics of composite value (CV) and FSCORE components

0.06
0.11
3,035
0.03
0.03
0.19
1,400
0.02
0.07

2.14
0.23
0.53
0.20
0.01

75th
percentile

0.26
0.36
301,911
0.29
0.25
2.92
82,450
0.21
0.65

8.70
4.72
8.53
1.12
0.10

Max

0.08
0.11
50,720
0.10
0.08
0.62
11,245
0.05
0.21

1.51
0.98
1.49
0.24
0.02

Standard
deviation

83.40
71.96
55.59
63.20
54.96
50.69
61.99
48.37
44.74

Percent of
Indicator = 1

JulyAugust 2012 Supplement 65

All firms
Book-to-market (BM)
Value
High_BM
Mid_BM
Glamor
Low_BM
Difference
Value glamor
p- or Z-value
Earnings-to-price (EP)
Value
High_EP
Mid_EP
Glamor
Low_EP
Difference
Value glamor
p- or Z-value
Cash-flow-to-price
Value
High_CP
Mid_CP
Glamor
Low_CP

0.5215

0.4714
0.4963

0.6079

0.1365
***

0.4456
0.4619

0.6834

0.2378
***

0.4518
0.4565

0.6864

0.0567
0.0203

0.0722

0.1289
0.0000

0.0379
0.0172

0.0577

0.0956
0.0000

0.0621
0.0123

0.0885

10th
percentile

0.0128

Mean

0.3901

0.2383
0.2634

0.1416

0.3827

0.2411
0.2670

0.1004

0.3481

0.2477
0.2881

0.2924

25th
percentile

0.1588

0.0283
0.0702

0.1051
0.0000

0.1423

0.0372
0.0755

0.0801
0.0000

0.1199

0.0398
0.0833

0.0795

Median

0.0878

0.2201
0.1444

0.0800
***

0.1172

0.1972
0.1410

0.1369
***

0.0965

0.2334
0.1468

0.1555

75th
percentile

Table 2. Annual buy-and-hold returns using a value investment strategy

0.5119

0.6530
0.4814

0.0450

0.6161

0.5711
0.4638

0.2780

0.4413

0.7193
0.4911

0.5383

90th
percentile

1.0240

0.8063
0.6162

0.3725

1.0784

0.7059
0.6422

0.1529

0.7529

0.9058
0.7840

0.8151

Standard
deviation

6.0329

5.9311
2.5326

2.0577

6.0652

4.0075
3.8289

0.8413

5.6447

4.8034
6.6026

5.6884

Skewness

94.7996

85.6293
26.1371

49.9750

91.4352

41.4602
49.3383

1.5430

75.7725

77.3155
135.2725

98.4273

Kurtosis

32.62

45.86
40.06

10.13

34.86

44.99
39.04

10.04

34.90

44.94
39.05

39.57

Percent
positive

3,538

3,537
4,735

3,540

3,541
4,729

3,536

3,536
4,738

11,810

66
Emerging Markets Finance & Trade

Difference
Value glamor
p- or Z-value
Sales growth (SG)
Glamor
High_SG
Mid_SG
Value
Low_SG
Difference
Value glamor
p- or Z-value
Share turnover (ST)
Glamor
High_ST
Mid_ST
Value
Low_ST
Difference
Value glamor
p- or Z-value
Composite value (CV)
Value

0.2346
***

0.5246
0.4700

0.6149

0.0903

0.7096
0.4747

0.4259

0.2837
***

0.1506
0.0000

0.0344
0.0065

0.0173

0.0171
0.4052

0.1298
0.0225

0.0566

0.1864
0.0000

0.1656

0.2316

0.3972
0.2653

0.0228

0.3267

0.3039
0.2594

0.1518

0.1355
0.0000

0.0328

0.1683
0.0619

0.0051
0.8202

0.0923

0.0974
0.0610

0.1305
0.0000

0.1103
***

0.1922

0.0819
0.1706

0.0336

0.1651

0.1315
0.1652

0.1323
***

0.0642

0.5606

0.4964
0.5573

0.0809

0.5955

0.5146
0.5243

0.1411

0.0478

0.7635

0.8113
0.8452

0.1908

0.9499

0.7591
0.7430

0.2177

2.2211

5.5205

3.2994
7.4990

3.4062

7.2070

3.8008
4.4721

0.1018

29.4632

80.8357

51.3725
138.1606

75.5990

123.3866

47.7876
70.3517

9.1703

13.06

44.95

31.89
41.28

1.59

39.21

37.63
41.27

13.24

(continues)

3,522

3,528
4,760

3,537

3,524
4,749

JulyAugust 2012 Supplement 67

0.4110
0.4827

0.6837

0.2727
***

0.4130
0.4793

0.6977

0.2847
***

0.1124

0.1893
0.0000

0.0726
0.0071

0.1094

0.1820
0.0000

10th
percentile

0.0769
0.0052

Mean

0.1797

0.3963

0.2166
0.2750

0.1766

0.3909

0.2143
0.2772

25th
percentile

0.1463
0.0000

0.1668

0.0205
0.0732

0.1421
0.0000

0.1619

0.0198
0.0726

Median

0.1548
***

0.0709

0.2257
0.1507

0.1621
***

0.0683

0.2304
0.1525

75th
percentile

0.1585

0.4696

0.6281
0.5101

0.1679

0.4602

0.6281
0.5198

90th
percentile

0.1739

0.9204

0.7465
0.7751

0.1117

0.8598

0.7481
0.8204

Standard
deviation

0.9012

4.9717

5.8729
6.5425

1.7366

4.2061

5.9427
6.9996

Skewness

23.5989

70.1672

93.7661
137.3198

38.2381

55.9576

94.1957
140.1574

Kurtosis

15.61

31.11

46.72
40.31

15.74

31.02

46.75
40.61

Percent
positive

3,446

3,579
4,785

3,540

3,527
4,743

Notes: Each June, all the firms are classified into three portfolios according to book-to-market ratio (BM), earnings-to-price ratio (EP), cash-flow-to-price ratio (CP), sales
growth (SG), share turnover (ST), and composite value (CV). Glamor, Middle, and Value consist of firm-years with an average rank below the 30th percentile, between the 30th and 70th percentiles, and above the 70th percentile, respectively. Size-adjusted equally weighted returns are calculated by subtracting KOSPI-matched size
decile portfolio returns from the corresponding raw returns. Return compounding begins at the start of July of each year. p-values are reported in parentheses. *, **, and
*** two-tailed significance at the 10 percent, 5 percent, and 1 percent levels, respectively.

High_CV
Mid_CV
Glamor
Low_CV
Difference
Value glamor
p- or Z-value
Raw composite value
(raw CV)
Value
High_Raw CV
Mid_Raw CV
Glamor
Low_Raw CV
Difference
Value glamor
p- or Z-value

Table 2. Continued

68
Emerging Markets Finance & Trade

JulyAugust 2012 Supplement 69

annual buy-and-hold return, which is higher than when using most individual proxies.
The difference in returns shows that the composite value is more efficient than individual
valuation proxies when conducting a simple value investment strategy, although the difference between using CV and ST as proxies is not significant.
One-Dimensional Investment Strategy: FSCORE Investment Strategy
Table 3 represents the annual size-adjusted buy-and-hold returns earned with an investment strategy that utilizes the FSCORE. A low FSCORE portfolio earns a negative
return of 10.53 percent, while a high FSCORE portfolio earns a positive return of 2.17
percent. Thus, on the basis of the whole sample, a strategy that consists of a long position
in high FSCORE firms and a short position in low FSCORE firms generates an annual
size-adjusted buy-and-hold return of 12.70 percent. This result counters Chang and
Kims (2003) argument that using financial conditions by setting the gross margin rate,
return on invested capital, and interest coverage ratio as proxy variables is irrelevant to
investment returns. This result also contrasts with the semi-strong form of the efficient
market hypothesis, which repudiates the feasibility of using public information such as
past stock prices, financial statements, or disclosures to earn greater returns.
However, the value premium in the FSCORE investment strategy is lower than that of
the simple value investment strategy and is congruent with the missed expectations hypothesis, which states that market participants underreact to information about changes in
a firms financial condition, as shown in the post-earnings-announcement drift effect.
Although the mean return does not consistently increase as the FSCORE increases,
the number of firms in the full sample that generate positive returns increases monotonically as the FSCORE increases. In the portfolio with the FSCORE of 0, 22.92 percent of
the firm-year observations are associated with positive size-adjusted returns. In contrast,
44.27 percent generate positive size-adjusted returns in the portfolio with FSCORE 9.
Another important finding is that the overall returns distribution is shifted to the right
(left) for a high (low) FSCORE, in keeping with Piostroski and So (2011).
Two-Dimensional Value Investment Strategy: Incongruent Strategy
Table 4 represents the annual size-adjusted equally weighted buy-and-hold returns earned
with the two-dimensional investment strategy, which utilizes both the valuation ratio and
the FSCORE. The FSCORE investment strategy conditioned on the value/glamor portfolio does not generate consistent positive size-adjusted returns. Applying the FSCORE
investment strategy to the value/glamor portfolio with a valuation ratio scaled by BM
to a value portfolio results in a significant positive return of 24.82 percent, but when it
is applied to a glamor portfolio, an insignificant return of 1.90 percent is generated. In
addition, in other valuation proxies, the FSCORE fails to classify all three value/glamor
portfolios as winners or losers. However, the value investment strategy conditioned on the
FSCORE portfolio generates significant positive annual size-adjusted returns, except for
the variables BM, which has a low FSCORE, and SG with all level of FSCORE. When
the variable CV is used, the value investment strategy earns positive returns of 17.05
percent in low FSCORE firms and 19.41 percent in high FSCORE firms.
These results indicate that the value investment strategy is more efficient than the
FSCORE investment strategy when one dimension is subject to a condition, but this is
because the return of the FSCORE investment strategy is also lower than the return of
the value investment strategy when there are no restrictions.

All firms
FSCORE
0
1
2
3
4
5
6
7
8
9
Low (03)
Mid (46)
High (79)
High-low
p- or Z-value

0.5215

0.7915
0.6998
0.6918
0.6092
0.5828
0.5464
0.4727
0.4458
0.4864
0.4432
0.6515
0.5208
0.4577
0.1938

0.2737
0.1227
0.1384
0.0722
0.0130
0.0131
0.0089
0.0210
0.0276
0.0003
0.1053
0.0047
0.0217
0.1270
0.0000***

10th
percentile

0.0128

Mean

0.4201
0.3865
0.3647
0.3354
0.3196
0.2817
0.2598
0.2608
0.2708
0.2625
0.3540
0.2805
0.2652
0.0888

0.2924

25th
percentile
Median

0.1724
0.1287
0.1665
0.1294
0.0856
0.0658
0.0686
0.0519
0.0606
0.0354
0.1432
0.0714
0.0522
0.0910
0.0000***

0.0795

Panel A; Size-adjusted buy-and-hold returns by FSCORE

0.0076
0.0236
0.0631
0.1009
0.1513
0.1668
0.1584
0.1802
0.1891
0.2026
0.0811
0.1595
0.1856
0.1045

0.1555

75th
percentile

0.2670
0.5369
0.3990
0.4891
0.5612
0.5811
0.5309
0.5500
0.5777
0.5525
0.4568
0.5580
0.5573
0.1005

0.5383

90th
percentile

Table 3. Annual buy-and-hold returns using an FSCORE investment strategy

0.7445
1.2226
0.9351
1.0077
1.0617
0.7853
0.6118
0.6248
0.7145
0.5033
1.0116
0.8088
0.6483
0.3633

0.8151

Standard
deviation

1.6677
3.8504
2.8214
5.7832
8.8955
3.4959
1.2937
5.7385
4.5598
0.3963
4.5528
6.5056
5.0628
0.5100

5.6884

Skewness

5.7216
40.0435
35.2968
87.6935
143.5615
31.3877
20.5210
83.4220
46.5791
6.6896
64.0722
121.6956
65.6569
1.5847

98.4273

Kurtosis

22.92
28.57
30.90
35.19
38.59
40.57
40.73
43.47
43.40
44.27
32.61
40.13
43.51
3.38

39.57

Percent
positive

48
322
809
1,222
1,534
2,196
2,298
1,992
1,136
253
2,401
6,028
3,381

11,810

70
Emerging Markets Finance & Trade

0.0115
0.0021
0.0254
0.0139
0.4438

0.0526
0.0154
0.0178
0.0704
0.0000***

CFO
0.0047
0.0467
0.0107
0.0154
0.4142

NI
0.0798
0.0165
0.0199
0.0997
0.0000***

ACCRUAL
0.0020
0.0041
0.0269
0.0249
0.1918

LEVER
0.0360
0.0319
0.0268
0.0092
0.6179

C_LIQUID

0.0681
0.0131
0.0044
0.0725
0.0000***

ISSUANCE

0.0086
0.0093
0.0222
0.0136
0.4618

MARGIN

0.0253
0.0002
0.0089
0.0164
0.3888

TURN

Notes: The FSCORE investment strategy consists of a long position in high FSCORE firms and a short position in low FSCORE firms. Low FSCORE, Middle
FSCORE, and High FSCORE consist of firm-years with an FSCORE less than or equal to 3, between 4 and 6, and greater than or equal to 7, respectively. p-value and
Z-value for differences in mean and median returns between high and low FSCORE portfolios are from t-tests of means and sign-ranked Wilcoxon tests, respectively.
*, **, and *** two-tailed significance at the 10 percent, 5 percent, and 1 percent levels, respectively.

Low (03)
Mid (46)
High (79)
High-low
p- or Z-value

ROA

Panel B: Size-adjusted buy-and-hold returns by FSCORE component

JulyAugust 2012 Supplement 71

0.0847

0.0522

0.0190
(0.6558)

Mid (46)

High (79)

High-low

691
1,775
1,070

0.0712

FSCORE
Low (03)

Returns using
incongruent
strategy
Returns using
congruent
strategy
N
Low (03)
Mid (46)
High (79)

0.0722

All Firms

948
2,404
1,386

0.1288
(0.0000)***

0.0071

0.0176

0.1359

0.0203

762
1,849
925

0.0458
(0.3097)

0.2482
(0.0000)***
0.2214
(0.0000)***

0.1502

0.0736

0.0980

0.0567

High_BM

Low_BM

Mid_BM

Value

Glamor

Book-to-market

0.0268
(0.6280)
0.1583
(0.0000)***
0.2024
(0.0000)***

0.1289
(0.0000)***

Valueglamor

1,223
1,758
559

0.0948
(0.0257)**

0.0433

0.0063

0.1381

0.0577

Low_EP

Glamor

Table 4. Annual buy-and-hold returns using a two-dimensional value investment strategy

784
2,447
1,498

0.0931
(0.0035)***

0.0167

0.0191

0.0764

0.0172

Mid_EP

394
1,823
1,324

0.0175
(0.6509)

0.1155
(0.0014)***
0.1928
(0.0000)***

0.0547

0.0471

0.0608

0.0379

High_EP

Value

Earnings-to-price

0.0773
(0.0970)*
0.0534
(0.0854)*
0.0980
(0.0014)***

0.0956
(0.0000)***

Valueglamor

72
Emerging Markets Finance & Trade

0.0501

0.0854

0.0591
(0.1566)

Mid (46)

High (79)

High-low

1,225
1,743
570

0.1445

FSCORE
Low (03)

Returns using
incongruent
strategy
Returns using
congruent
strategy
N
Low (03)
Mid (46)
High (79)

0.0885

All firms

805
2,440
1,490

0.0763
(0.0091)***

0.0053

0.0037

0.0710

0.0123

371
1,845
1,321

0.0352
(0.3991)

0.1365
(0.0010)***
0.2308
(0.0000)***

0.0863

0.0675

0.0502

0.0621

High_CP

Low_CP

Mid_CP

Value

Glamor

Cash-flow-to-price

0.0943
(0.0588)*
0.1176
(0.0000)***
0.1717
(0.0000)***

0.1506
(0.0000)***

Valueglamor

1,009
2,008
520

0.1375
(0.0016)***

0.0474

0.0025

0.0901

0.0173

Low_SG

Value

795
2,427
1,527

0.1306
(0.0010)***

0.0254

0.0313

0.1052

0.0065

Mid_SG

597
1,593
1,334

0.0975
(0.0130)**

0.1384
(0.0006)***
0.1784
(0.0000)***

0.0074

0.0331

0.131

0.0344

High_SG

Glamor

Sales growth

(continues)

0.0409
(0.4014)
0.0356
(0.2115)
0.0400
(0.2276)

0.0171
(0.4052)

Valueglamor

JulyAugust 2012 Supplement 73

0.0526

0.0536

0.0246
(0.6445)

Mid (46)

High (79)

High-low

910
2,443
1,407

0.1107
(0.0026)***

0.0409

0.0463

0.0698

0.0225

979
1,727
822

0.1341
(0.0173)**

0.1784
(0.0000)***
0.2879
(0.0000)***

0.0559

0.1058

0.2343

0.1298

0.3125
(0.0000)***
0.1584
(0.0000)***
0.1095
(0.0005)***

0.1864
(0.0000)***

Valueglamor

1,044
1,665
831

0.0849
(0.0290)**

0.0846

0.0905

0.1695

0.1124

Low_CV

Glamor

912
2,415
1,416

0.0973
(0.0109)**

0.0137

0.0134

0.0836

0.0052

Mid_CV

445
1,948
1,134

0.0856
(0.0210)**

0.1085
(0.0049)***
0.2790
(0.0000)***

0.1095

0.0752

0.0010

0.0769

High_CV

Value

Composite value

0.1705
(0.0003)***
0.1657
(0.0000)***
0.1941
(0.0000)***

0.1893
(0.0000)***

Valueglamor

Notes: The incongruent strategy consists of a long position in value firms with a high FSCORE and a short position in glamor firms with a low FSCORE. The congruent
strategy consists of a long position in value firms with a low FSCORE and a short position in glamor firms with a high FSCORE. Each June, all the firms are classified
into three portfolios according to their book-to-market ratio (BM), earnings-to-price ratio (EP), cash-flow-to-price ratio (CP), sales growth (SG), share turnover (ST),
and composite value (CV). Glamor, Middle, and Value consist of firm-years with an average rank below the 30th percentile, between the 30th and 70th percentiles,
and above the 70th percentile, respectively. Low FSCORE, Middle FSCORE, and High FSCORE consist of firm-years with an FSCORE less than or equal to 3,
between 4 and 6, and greater than or equal to 7, respectively. Size-adjusted equally weighted returns are calculated by subtracting KOSPI-matched size decile portfolio
returns from the corresponding raw returns. Return compounding begins at the start of July in each year. p-values are in parentheses. *, **, and *** two-tailed significance at the 10 percent, 5 percent, and 1 percent levels, respectively.

512
1,858
1,152

0.0782

FSCORE
Low (03)

Returns using
incongruent
strategy
Returns using
congruent
strategy
N
Low(03)
Mid(46)
High(79)

0.0566

High_ST

Low_ST

Mid_ST

Glamor

Share turnover

Value

All firms

Table 4. Continued

74
Emerging Markets Finance & Trade

JulyAugust 2012 Supplement 75

Next is the result of the two-dimensional investment strategy when both the valuation
ratio and the FSCORE are used. The incongruent investment strategy uses the large gap
in expectation errors and consists of a long position in value firms with a high FSCORE
and a short position in glamor firms with a low FSCORE. The congruent investment
strategy uses the small gap in expectation errors and consists of a long position in value
firms with a low FSCORE and a short position in glamor firms with a high FSCORE.
In the case of the incongruent investment strategy, the positive size-adjusted buy-andhold returns of all six variables are significant at the 1 percent level. Specifically, sales
growth (SG) generates a return of 17.84 percentthe lowest of all six variables using
the incongruent strategyand CV generates a high return of 27.90 percent, which is
8.97 percent higher than the return of 18.93 percent earned by the one-dimensional value
investment strategy. The return difference indicates that a two-dimensional investment
strategy, which employs both the valuation ratio and the FSCORE, is more efficient than
the one-dimensional investment strategy. The congruent investment strategy using ST
and CV generates a significant positive return; however, the return is lower than that of
the incongruent investment strategy.
When we use the composite-value variable (CV), which had a high return rate using
both the value investment strategy and the incongruent strategy, the FSCORE strategy,
Value strategy, Congruent Strategy, and Incongruent Strategy generate returns of 12.70
percent, 18.93 percent, 8.56 percent and 27.90 percent, respectively. This result indicates
that using a valuation ratio rather than the FSCORE is more profitable in a one-dimensional
investment strategy and supports the previous outcome that a two-dimensional strategy
yields a higher return than a one-dimensional strategy.
The FSCORE investment strategy shows negative returns in seven of the twenty-seven
years in the sample period, while the incongruent strategy shows negative returns in only
four years. Therefore, we conclude that the incongruent strategy is more profitable and
less risky than the FSCORE investment strategy.
Two-Dimensional Value Investment Strategy Based on Market Conditions
To test if one- and two-dimensional investment strategies earn different returns depending
on market conditions, we divided the study sample into bull and bear markets based on
the annual market returns by finding the average of the monthly returns of the KOSPI
market index from July in year t 1 (the year before the portfolio formation year) to
June in year t. From 1984 to 2010, there were fifteen years (55.56 percent) of bull market
conditions and twelve years (44.44 percent) of bear market conditions. Thus bull markets
were 11.11 percent more frequent than bear market. Samples included in the bear market
are 5,918 firm-years and bull market are 5,892 firm-years. Table 5 represents the annual
size-adjusted buy-and-hold returns earned with one-and two-dimensional value investment
strategies based on market condition. The results from both the bull and bear markets
are similar to the results of the full sample. In both cases, a two-dimensional strategy
earns a higher return than a one-dimensional strategy. In a bear (bull) market, the return
earned by the incongruent strategy using CV, which is 34.60 percent (21.43 percent), is
13.05 percent (5.12 percent) higher than the return earned by the one-dimensional value
investment strategy, which is 21.55 percent (16.31 percent). This result proves that a twodimensional value investment strategy is more efficient regardless of market conditions.
Furthermore, if we look at the returns from a one-dimensional value investment strategy
during a bear (bull) market on each valuation ratio, higher returns can be earned using

76

Emerging Markets Finance & Trade

Table 5. Annual buy-and-hold returns using a two-dimensional value investment

strategy based on market conditions

Panel A: Bear market

Book-to-market
Earnings-to-price
Cash-flow-to-price
Sales growth
Share turnover
Composite value
Panel B: Bull market
Book-to-market
Earnings-to-price
Cash-flow-to-price
Sales growth
Share turnover
Composite value

One-dimensional
value strategy

Incongruent
strategy

Congruent
strategy

0.1100
(0.0007)***
0.1077
(0.0032)***
0.1433
(0.0001)***
0.0057
(0.8667)
0.2563
(0.0000)***
0.2155
(0.0000)***

0.2677
(0.0002)***
0.2250
(0.0006)***
0.2776
(0.0000)***
0.1848
(0.0059)***
0.4050
(0.0000)***
0.3460
(0.0000)***

0.1023
(0.1692)
0.0804
(0.1791)
0.0385
(0.5599)
0.1256
(0.0530)*
0.204
(0.0380)**
0.0991
(0.0972)*

0.1479
(0.0000)***
0.0834
(0.0003)***
0.1579
(0.0000)***
0.0284
(0.2096)***
0.1162
(0.0000)***
0.1631
(0.0000)***

0.2015
(0.0016)**
0.1569
(0.0001)***
0.1857
(0.0000)***
0.1493
(0.0016)***
0.1489
(0.0017)***
0.2143
(0.0000)***

0.0415
(0.2632)
0.0598
(0.1791)
0.1253
(0.0056)***
0.0716
(0.1061)
0.0332
(0.3812)
0.0774
(0.0392)**

Notes: Panel A shows returns when the market condition is bad, and Panel B shows returns when
the market condition is good. The incongruent strategy consists of a long position in value firms
with a high FSCORE and a short position in glamor firms with a low FSCORE. The congruent
strategy consists of a long position in value firms with a low FSCORE and a short position in glamor
firms with a high FSCORE. Each June, all the firms are classified into three portfolios according to
book-to-market ratio (BM), earnings-to-price ratio (EP), cash-flow-to-price ratio (CP), sales growth
(SG), share turnover (ST), and composite value (CV). Glamor, Middle, and Value consist of
firm-years with an average rank below the 30th percentile, between the 30th and 70th percentiles, and
above the 70th percentile, respectively. Low FSCORE, Middle FSCORE, and High FSCORE
consist of firm-years with an FSCORE less than or equal to 3, between 4 and 6, and greater than or
equal to 7, respectively. Size-adjusted equally weighted returns are calculated by subtracting KOSPImatched size decile portfolio returns from the corresponding raw returns. Return compounding begins
at the start of July in each year. p-values are in parentheses. *, **, and *** two-tailed significance at
the 10 percent, 5 percent, and 1 percent levels, respectively.

composite value (CV) than using single valuation ratios and using share turnover (ST)
in the case of a bear market. The result shows that liquidity is more important during a
declining market.
In both one- and two-dimensional investment strategies, the higher return during a bear
market than during a bull market shows their protective abilities. Our outcome is similar
to Kim and Lee (2006), who proved the protective ability of the value investment strategy

JulyAugust 2012 Supplement 77

through separately investigating the monthly return during bull and bear markets. Specifically, the two-dimensional investment strategy using CV earns a return of 34.60 percent
during a bear market, which is 13.17 percent higher than the 21.43 percent it generates
during a bull market. In addition, the one-dimensional value investment strategy using
CV earns a return of 21.55 percent during a bear market, which is 5.24 percent higher
than the 16.31 percent it generates during a bull market.
Robustness Test
Two-Dimensional Value Investment Strategy
To examine whether the abnormal returns of a two-dimensional strategy come from rewards
to risk or expectation errors, we employed the FamaFrench three-factor model and fourfactor model with turnover as a liquidity factor. Our four-factor model contains market
premium, size (small minus big), book-to-market ratio (high minus low), and liquidity
(nonpopular minus popular). We included a liquidity variable as a risk factor in the fourfactor model to measure risk-adjusted returns because the results of Yun et al. (2009) show
that liquidity has more explanatory power than book-to-market ratio in Korea.
We construct the market risk premium as the difference between the monthly return of
KOSPI index and the monthly converted rate of overnight rates.5 While the three-month
Treasury bill rate is used as a proxy for a risk-free rate in the United States, there is no
such asset in Korea. In previous studies, many alternative rates are used, such as rate of
saving deposits, certificate of deposits (CD) rate, and overnight rate (Dokko et al. 2001;
Kim and Hong 2008; Yun et al. 2009). We use the overnight rate as a proxy for risk-free
rate. We follow Fama and French (1992, 1993) to construct the SMB (small minus big)
size and HML (high minus low) book-to-market portfolios. In June of each year t, we
rank all KOSPI stocks on size, market capitalization (price times shares outstanding).
We then use the median size to create two groups, small and big (S and B). We also
break stocks into three book-to-market groups based on the breakpoints for the bottom
30 percent (Low), middle 40 percent (Medium), and top 30 percent (High) of the ranked
values of BM. SMB (HML) measure the excess returns of small (value) portfolios over
big (growth) portfolios. To construct the performance of nonpopular stocks relative to
popular stocks (nonpopular minus popular, or NMP), we follow the method of Yun et al.
(2009) and use the mean monthly turnover ratio (trading volume over shares outstanding).
We divide the popular, middle, and nonpopular for the top 30 percent, middle 40 percent,
and bottom 30 percent of the ranked values of turnover ratio. The NMP is the difference
between the value weighted average returns of the nonpopular (bottom) portfolio and
those of the popular (top) portfolio. Because we require this information for the sixty
preceding months (5 years) to estimate the factor loadings for each firm, we can use the
model from 1986.
Table 6 presents equally weighted buy-and-hold returns earned by a two-dimensional
value investment strategy using three-factor and four-factor models. In all the cases except
the sales growth (SG) of controlling for four factors, returns using an incongruent strategy
are higher than returns using a one-dimensional value strategy. This implies that a twodimensional value investment strategy that also reflects accounting information (FSCORE) is
a useful investment strategy after controlling for risks. The abnormal return in the three-factor
(four-factor) model using the composite value (CV) is 19.06 percent (12.71 percent), which
is higher than the return of 9.37 percent (23.0 percent) gained using a one-dimensional
value investment strategy.

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Table 6. Annual buy-and-hold returns using a one- and a two-dimensional value

investment strategy controlling three factors and four factors
One-dimensional
value strategy
Panel A: Controlling three factors
Book-to-market
0.0014
(0.9429)
Earnings-to-price
0.0442
(0.0241)**
Cash-flow-to-price
0.1033
(0.0000)***
Sales growth
0.0272
(0.2330)
Share turnover
0.1390
(0.0000)***
Composite value
0.0937
(0.0000)***
Panel B: Controlling four factors
Book-to-market
0.0447
(0.2976)
Earnings-to-price
0.2636
(0.3640)
Cash-flow-to-price
0.1515
(0.0124)**
Sales growth
0.3980
(0.1793)
Share turnover
0.2772
(0.3459)
Composite value
0.2300
(0.4289)

Incongruent
strategy

Congruent
strategy

0.1321
(0.0003)***
0.1538
(0.0000)***
0.1726
(0.0000)***
0.1852
(0.0000)***
0.2473
(0.0000)***
0.1906
(0.0000)***

0.1624
(0.0006)***
0.1683
(0.0491)**
0.0225
(0.8821)
0.0692
(0.2668)
0.0325
(0.2858)
0.0688
(0.2573)

0.0891
(0.0120)**
0.1032
(0.0002)***
0.1248
(0.0000)***
0.1344
(0.0000)***
0.1403
(0.0000)***
0.1271
(0.0000)***

0.1169
(0.0000)***
0.0806
(0.1073)
0.3761
(0.3693)
0.0961
(0.5322)
0.0199
(0.5513)
0.0334
(0.4150)

Notes: Panel A shows returns controlling three factors (market premium, size, and BM), and Panel B
shows returns four factors (market premium, size, BM, and liquidity). The one-dimensional value
investment strategy consists of a long position in high value firms and a short position in glamor
firms. The incongruent strategy consists of a long position in value firms with a high FSCORE and a
short position in glamor firms with a low FSCORE. The congruent strategy consists of a long position
in value firms with a low FSCORE and a short position in glamor firms with a high FSCORE. Each
June, all the firms are classified into three portfolios according to their book-to-market ratio (BM),
earnings-to-price ratio (EP), cash-flow-to-price ratio (CP), sales growth (SG), share turnover (ST),
and composite value (CV). Glamor, Middle, and Value consist of firm-years with an average
rank below the 30th percentile, between the 30th and 70th percentiles, and above the 70th percentile,
respectively. Low FSCORE, Middle FSCORE, and High FSCORE consist of firm-years with an
FSCORE less than or equal to 3, between 4 and 6, and greater than or equal to 7, respectively. Sizeadjusted equally weighted returns are calculated by subtracting KOSPI-matched size decile portfolio
returns from the corresponding raw returns. Return compounding begins at the start of July in each
year. p-values are in parentheses. *, **, and *** two-tailed significance at the 10 percent, 5 percent,
and 1 percent levels, respectively.

JulyAugust 2012 Supplement 79

Conclusion
This paper tests whether the two-dimensional value investment strategy that incorporates
both the value investment strategy and financial statement analysis is effective in the
Korean stock market. We use the FSCORE from Piotroski (2000) as the proxy variable
for the financial statement analysis; book-to-market ratio (BM), earnings-to-price ratio
(EP), cash-flow-to-price ratio (CP), sales growth (SG), and equity share turnover (ST)
for the individual value ratios; and composite value (CV) in accordance with Piotroski
and So (2011).
In all the cases except for one in which sales growth (SG) is used as the valuation ratio,
the simple value investment strategy that consists of a long position in value stocks and
a short position in glamor stocks proves the presence of a value premium on the Korean
stock market. The outcome supports the missed expectation hypothesis, which states that
market participants underreact to information about changes in a firms financial condition, and disproves the semi-strong form of the efficient market hypothesis.
The two-dimensional value investment strategy that incorporates financial statement
analysis into the simple value investment strategy shows significant positive returns on
all six value ratios, ranging from 17.84 percent to 28.79 percent. When composite value
is used as the valuation proxy, the two-dimensional value investment strategy, compared
to the one-dimensional value investment strategy, generates a return of 27.90 percent,
which is at least 8.97 percent higher. This result shows that using an investment strategy
that combines the valuation ratio and the FSCORE is effective not only in the U.S. stock
market, but also in emerging stock markets such as the Korean stock market.
We divide the total sample into bull and bear markets and compare the returns of the
two-dimensional and one-dimensional strategies. The result shows that a two-dimensional
strategy generates a higher return in both bull and bear markets, and earns the highest
returns when the composite value is used. In bear markets, the two-dimensional value
investment strategy using share turnover has higher returns than using composite value,
which implies that liquidity is important in a bear market. Moreover, the higher return
rate during a bear market verifies the protective ability of the value investment strategy,
which suggests various uses for the value investment strategy depending on market
conditions.
Notes
1. In this paper, the value investment strategy (one-dimensional value investment strategy)
is the simple value investment strategy, and the two-dimensional value investment strategy is an
advanced strategy that incorporates both traditional value investment strategy and financial statement information.
2. The fiscal year in this paper is identical to the calendar year because the sample consists of
firms whose fiscal year ends in December.
3. See Piotroski and So (2011, p. 40) for a detailed discussion of these two conflicting
opinions.
4. The Korean stock market is composed of the KOSPI market and the KOSDAQ (Korea Securities Dealers Automated Quotation) market. The KOSDAQ market, which opened in 1996, is similar
to the Nasdaq in the United States in that both are for small, medium-size, or venture businesses.
The KOSDAQ is excluded from the sample because most firms on the KOSDAQ are glamor stocks,
which are not appropriate samples to validate the usefulness of the value investment strategy.
5. The overnight rate is generally the rate that large banks use to borrow and lend from one
another on the overnight market.

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