Using fundamental analysis of Mexican inflation accounting disclosures to explain returns

The value to investors of financial statements produced by a current-cost, constant-price-level-adjusted measurement system has long been a contentious issue in accounting. Mexico provides a unique laboratory for empirical investigations of this issue because companies traded on the Mexican Bolsa have reported this type of information since 1984. No other country has implemented a comprehensive current-cost, constant-price-level-adjusted measurement system as the primary reporting system.;This study investigates the value relevance of the Mexican financial accounting data by examining its association with contemporaneous stock returns. A fundamental-information analysis framework is used because this framework explicitly incorporates a broad information set that is representative of the types of analyses conducted by analysts. In addition to earnings, fundamental analysis uses comparative analysis of year-to-year changes in detailed financial information. These changes provide “signals” that analysts use to estimate future cash flows to the firm. Several studies have found these changes provide incremental information over that inferred only by earnings (Lev and Thiagarajan [1993], Abarbanell and Bushee [1997, 1998]).;This is the first attempt to study the use of accounting information in an inflationary economic environment, such as that of Mexico, using a fundamental analysis framework. Many of the most important arguments proposed by Edwards and Bell (E&B) (1961) for accounting in an inflationary environment system focus on components of the income statement and balance sheet. Fundamental analysis provides a means to test whether signals based on changes in price-level-adjusted amounts provide value-relevant information to the market.;Results show that fundamental signals obtained from current cost, constant-price-level-adjusted financial information provide significant incremental value-relevant information when compared with aggregate earnings. Concerning the value relevance of specific signals, Mexican companies that are able to control the level of selling and administrative expenses relative to the level of sales and able to maintain their gross margins have higher returns.