Introduction:

This literature review focuses on topics related with fundamental analysis such as short sellers taking positions on different stocks, the importance of fundamental analysis in the information arbitrage process, predicting stock returns for growth firms and the approach taken for stock selection by none other than Warren Buffett the Oracle of Omaha and Benjamin Graham.

Review of Research papers:

In their paper Short-sellers, fundamental analysis and stock returns, Patricia M. Dechowa, Amy P. Huttonb, Lisa Meulbroekb, Richard G. Sloana argues that firms with low ratios of fundamentals (such as earnings and book values) to market values are known to have systematically lower future stock returns. They further argue that short sellers uses information in these ratios to take positions in stocks with lower expected future returns. They identify the characteristics of the securities targeted by short-sellers. They identify whether short-sellers target stocks of firms that are priced high relative to fundamentals, such as earnings and book values. They emphasize that there is a strong relation between the trading strategies of short-sellers and ratios of fundamentals to market prices. They show that short sellers refine their avoid securities where the transactions costs of short selling are high. Second, short sellers supplement their trading strategies by using information in addition to that in fundamental-toprice ratios that has predictive ability with respect to future returns. Third, they show that short sellers avoid shorting securities with low fundamental-to-price ratios when the low ratios are attributable to temporarily low fundamentals. They gathered financial statement data, stock returns, institutional holdings data, and short interest data for testing their predictions. The fundamental to price ratios that they used for their research are earnings to price ratio, cash flow to price ratio, book to market ratio and value to market ratio. Their results confirm that short-sellers load up on stocks with low fundamental-toprice ratios, but simultaneously avoid stocks with high transaction costs. On the other hand, short-sellers may choose to not take a position in a stock with a low fundamental-to-price ratio if they have additional information indicating that the security is not likely to experience a price decline. While stocks with low fundamental-to-price ratios give lower stock returns 'on average, it is not necessary that each low ratio stock underperforms, for eg: Cisco systems with a low ratios have performed consistently well for extended periods of time. There can be firms with temporarily low ratios due to temporarily low fundamentals, for egg : cash flows are frequently temporarily low due to non-recurring items. Thus, the contribution of their study is to demonstrate that short-sellers act as if they use these ratios to to identify overpriced stock, and then cover their positions as prices decline to bring the stocks values back in line with the fundamentals. Also their study showed that short-sellers are able to distinguish between firms where the low fundamental-to-price ratios are driven by
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temporarily high stock prices versus temporarily low fundamentals. Finally, they documented that short sellers supplement information in the low fundamental-to-price ratios with additional information that predicts future stock returns. In their research paper, "The Role of Fundamental Analysis in Information Arbitrage: Evidence from Short Seller Recommendations",Hemang Desai,Srinivasan Krishnamurthy and Kumar Venkataraman examines whether information arbitrageurs attempt to exploit the return predictability in valuation and fundamental signals. By using a unique database of short sell recommendations, they documented that firm fundamentals, such as magnitude of accruals, sales growth, gross margin, and SG&A expenses, and valuation indicators, such as book-to-market ratio and return momentum, contain valuable information correlated with the trading behavior of short sellers. Overall, their findings present additional insights into the decision process of short sellers and validate the importance of fundamental analysis in the information arbitrage process. In their study, they provide direct evidence on the trading behavior of information arbitrageurs by examining a unique database of short sell recommendations. While prior research has shown that valuation and fundamental variables predict returns, their study furthers these analyses by documenting that information arbitrageurs attempt to exploit this predictability. Such a finding not only enhances their understanding of the information arbitrage process but also highlights the role of fundamental analysis in price formation. They have built a model that predicts short recommendations using context-specific financial performance measures.They have obtained the data for their study from an independent research firm. Their objective is to determine whether fundamental analysis helps short sellers identify firms whose strong past performance is not sustainable. In summary, their research paper provides new insights into the decision process of information arbitrageurs. The key contributions of the study are threefold. First, and most importantly, the study provides new insights into the information arbitrage process. Information arbitrageurs attempt to exploit the return predictability in valuation and fundamental signals, suggesting a direct link between the literature on the predictive ability of fundamental signals and the literature on the trading behavior of information arbitrageurs. Second, the study validates the importance of accounting-based information for short sellers by examining a database of short recommendations. The authors approach furthers the analyses from prior research on short seller behavior using reported short interest. They argue that short recommendations provide a more precise signal of valuation motivated shorting than reported short interest, which aggregates both valuation and arbitrage shorts. Third, they document that the short recommendation model can distinguish between valuation shorts and arbitrage shorts. This distinction is important because the information content of these two sources of short interest is different and the increasing use of arbitrage related short selling in recent years has contributed to a weakened relation between short interest and future returns. In their research report, "Prediction of stock returns for growth firms - a fundamental analysis",Meena Sharma and Preeti examines whether fundamental analysis involving two set of signals named traditional and growth, when applied on growth stock, it differentiates the extreme performers. Their study is conducted on the sample of 180 low book to market(BM) firms listed with National Stock Exchange, during the period 1998 to 2007.Their research indicate that
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fundamental analysis based on growth signals is very successful in differentiating between the firms that are likely to perform well in future and may perform poorly among the low book to market firms. Investors widely classify the stocks into value and growth. Value investors look for the stocks that are trading at less than their apparent worth, but on the other hand growth investors focus on the future potential of the firm and buy companies that are trading higher than their current intrinsic worth with the belief that the companies intrinsic worth will grow and exceed their current valuation. This paper examines whether an accounting based fundamental analysis strategy when applied to portfolio of low book to market firms (growth firms) can shift the distribution of returns earned by the investors and also which set of signals are more useful in earning excess returns. The authors evaluate the usefulness of fundamental analysis in terms of their ability to assist growth stock investors in forecasting what to buy and what to sell and also if buying and selling decisions consistently earns significant excess returns. The objectives of their study are : a) To differentiate between fundamentally strong and fundamentally weak firms among low book to market firms.b) To investigate if fundamentally strong firms from the sample of low book to market firms earn significant excess returns.c) To identify which set of signals whether traditional or growth are more effective in differentiating the returns of high and low group firms. Important point to note is that they have excluded firms in the service sector in their study because book value does not carry much meaning for service based firms with few tangible assets. In traditional signals, they have considered factors such as profitability, cash flow performance, operating efficiency and liquidity, while in growth signals they have considered stability of earnings, research and development expenditure and advertising expenditure . Thus, the research paper concludes that accounting based fundamental analysis strategy, if following traditional and growth signals and applied to a broad portfolio of low BM firms, can shift the distribution of returns earned by investors by differentiating between strong and weak firms. Their study demonstrates that investors can use past historical information to eliminate firms with poor future prospects from portfolio of low BM firms. In his research paper, "Is Fundamental Analysis Effective for Growth Stocks?",Partha S. Mohanram examines whether applying an accounting based fundamental analysis strategy can help investors earn excess returns on a broad sample of low book to market (BM) firms. The BM ratio of a firm is affected by both valuation as well as conservatism. Using another valuation metric such as the E/P ratio may isolate firms that have low BM ratios because of high valuations. Among firms with low BM ratios, those with low EP ratios as well are more likely to be overvalued and hence may see greater reversals in future periods. Partha analyzed the stock market reaction to future earnings estimates in two ways. First, he examines the extent to which analysts are surprised by future realizations of earning. Second, he studied the stock markets reaction around the window of quarterly earnings announcements. His findings support the conjecture that the stock market fails to impound the implications of current fundamentals for future fundamentals for growth firms and is surprised at the realization of future fundamentals.

Partha S. Mohanram created a model in which he includes both traditional fundamental signals related to cash flows and leverage as well as measures based on the stability of earnings and growth, and the levels of R&D, capital expenditures and advertising expenses. He then created portfolios based on his model and compared the performance of these portfolios with a one-year and two-year horizon. The findings of his model are able to differentiate between future winners and losers. His results were robust across partitions based on firm size, stock price, analyst following, valuation in terms of E/P and did not depend on the inclusion or exclusion of IPO firms. His study indicates that the stock market does not understand the correlation between current fundamentals and future fundamentals. He founds that the stock market appears to ignore the fundamentals and then gets surprised when fundamentally strong firms continue to stay strong and weak firms continue their weak performance. Traditionally, the focus for growth firms has been on non-fundamental aspects of their operations. Analysts have looked outside the financial statements in search for drivers of future value. The growth signals outlined in Partha's paper add considerable value in lieu of traditional fundamental analysis. His findings indicate that amongst growth firms, extreme performers can be identified from financial statement information itself. In addition to the traditional fundamentals, factors related to the stability and sustainability of growth and future oriented activities such as R&D and advertising add value in picking future winners. In their research paper , "Teaching the Fundamental of Ben Graham and Warren Buffett, James Kuhle and Suzanne M. Ogilby presents a fundamental approach to selecting common stocks based upon the precepts of Benjamin Graham and Warren Buffett. The paper presents different analysis and models to identify publicly traded corporations that are good buys based on intrinsic value and future prospects for growth.The purpose of this paper is to illustrate a systematic process for teaching fundamental stock analysis for the purpose of analyzing the potential investment opportunity of a publicly traded corporation. Benjamin Graham is often referred to as the father of Fundamental Analysis. The Graham model was based on information contained in the balance sheet and income statement. Grahams model used the net current asset variable, defined as current assets minus current liabilities minus preferred stock minus long-term debt. This net current asset variable was used to find those companies that were significantly undervalued or out of favor in the market. By purchasing stocks below the net current asset value, the investor buys a bargain because the fixed assets of the firm are purchased at a significant discount. The Graham model also takes into account the earnings per share (EPS), the expected earnings growth rate, and the current estimated yield on AAA rated corporate bonds market wide. Warren Buffett practices the wisdom of Ben Graham who declared the margin of safety is important because it is essentially impossible to pinpoint the precise intrinsic value of a business and that the best you can do is compute reasonable ranges of value based on reasonable assumptions. At the core of solid fundamental investment analysis is the ability to calculate, analyze, and interpret the meaning of financial ratios. The authors have divided their paper in three parts, the first part is to do ratio analysis and DuPont analysis on the Company Coca Cola .

The ratio analysis has four major categories. The first category deals with the relative liquidity of the firm referred to as the solvency ratios, the second category is of efficiency ratios, the third category consists of financial leverage ratios and the fourth category of ratios analyzes profitability. The ratio analysis of the Coca Cola Company indicates a superior company over the last three years. While the liquidity of the company suggests room for improvement in comparison to Pepsi, the majority of the activity, debt, and profitability ratios point toward an extremely strong financial condition. On similar lines, other ratios are compared with Coca cola's competitor Pepsi.The DuPont system is used in the analysis to consider the impact of various balance sheet and income statement components in the formation of return on equity. The DuPont analysis provides a framework for dissecting the firms financial statements in an effort to further diagnose trouble spots in the overall performance of the firm. In the second part, strategic financial analysis is done. Strategic financial analysis is comprised of both a quantitative and non-quantitative analysis. The quantitative data is used in the forecast of the future performance and intrinsic value determination. The non quantitative factors include, but are not limited to, determining whether the company has and maintain a monopoly type product(s) and can sustain a long-term competitive advantage with its products over the next 1020 years. In depth study of product ,brand ,sales along with financial statement analysis needs to be done.The non-quantitative analysis of Coke reveals that the company has many strengths and opportunities with minor weaknesses and threats. First, Coke is clearly a franchise product - this is its major strength. The ability to get the product to the customer at the least cost and when they want it is a strength that is surpassed only by Cokes advertising prowess. Internationally, Coca Cola has a major presence in both the Chinese and Indian markets with distribution networks that have been in place for a number of years. In the third part, intrinsic value of the company is determined. The total intrinsic value is composed of two sums. The first calculation for intrinsic value is the discounted ten-year cash flows summed and discounted at the investor. In this case, 15% reflects the minimum acceptable rate of return. The second component of intrinsic value is the residual value of cash flows beyond ten years with an assumed growth rate of 4% per year. Coca cola's intrinsic value was found to be greater than the market value ,which indicates a "BUY" on the stock. This paper has presented a systematic approach, using spreadsheets, for doing fundamental analysis. The forecast results in a total value for the firm today based on future cash flows that are compounded at various growth rates, the total intrinsic value of the firm is then divided by the number of outstanding shares to determine the intrinsic value per share. This value is then compared to the market price to determine if the stock is currently over- or under-valued.

Conclusion
Research papers of different scholars used fundamental analysis in different contexts like in short selling, identifying growth firms. In one of the research paper, the author showed how the great investors of all the time Benjamin Graham and Warren Buffett used fundamental analysis for buying stocks. There is not one single method of doing fundamental analysis, but the

important point taken from all reviews of different research paper is fundamental analysis if done diligently is indeed a profitable strategy when investing in the stock market.