Curious to see the predictability of fundemental financial measures, I decided to do a series of regression analysis on 4 important financial measures. I took the top 30 holdings of the TSX/S&P 60 Index and performed a regression analysis comparing 1 year returns against Net Margins, Return on Equity, P/E and EPS Growth.
Below are the regression analysis comparing 1 year returns to : Net Margins, Return on Equity, P/E and EPS Growth.
Taken individually, no financial measure can tell an investor any important information about the quality of an investment. Moreover, the most quoted financial measure, that of the P/E ratio actually has a positive correlation with returns and is the worst measure. However, when all the measures are combined together (see below) we get a strong positive correlation with an r value of 0.74. These discoveries reinforces the idea that individually no single financial measure is of any use; but when used in combination, financial fundemental measures are reasonably good at predicting potential returns.
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