External Financing,Growth and Stock Returns

In this paper we investigate the relation of the value/growth anomaly with the anomaly on corporate financing activities. We confirm and expand earlier results that value/growth and external financing indicators are, to some degree, related predictors of stock returns in the cross section. We show that external financing indicators are incrementally informative since they pick up stock returns associated with earnings quality. Portfolios that combine information from both these indicators generate significantly higher returns than portfolios containing each individual indicator. More importantly, our analysis strongly suggests that the external financing anomaly is, to some extent, distinct from the value/growth anomaly, in that it may also reflect investors’ misunderstanding of the effects of opportunistic earnings management.     

Expected earnings growth and portfolio performance

We form portfolios based on forecasted growth rates in earnings and apply stochastic dominance tests. Low expected-growth rate portfolios dominate high expected-growth rate portfolios. This suggests that the superior return performance of value stocks is not due to omitted risk factors but is a consequence of investors making systematic errors in forming earnings expectations. Fama and French (1992) extend and refine the results of previous studies that report relationships between stock returns and firm characteristics (e.g., Banz (1981), firm size; Rosenberg et al. (1985), book value to market value; Basu (1983) and Jaffe et al. (1989), earnings-to-price ratio; and Keim (1985), dividend yield).     

Industry Concentration,Firm Efficiency and Average Stock Returns: Evidence from Australia

This study examines the relationship between industry concentration and level of firm efficiency and their effect on cross-sectional stock returns in Australian market. Our analysis shows that industry concentration and firm efficiency have independent effects on stock returns. By forming 25 double-sorted portfolios based on industry concentration and firm efficiency, INEFFICIENT firms in concentrated industry earn highest stock returns, while EFFICIENT firms in concentrated industry earn lowest stock returns. Also we find that industry concentration appears to be associated with market share while efficiency has a greater effect on firm earnings. In our cross-sectional regressions, industry concentration shows a positive relationship with average stock returns while firm efficiency shows a negative association with average stock returns. The concentration and efficiency effects are persistent throughout the sample period and is robust after controlling for size and book-to-market.     

财务分析师盈利预测的投资价值:来自深沪A股市场的证据

本文研究了中国股票市场上财务分析师的盈利预测信息对投资者是否有价值。我们发现,可以利用公开的盈利预测制定可获利的套头交易策略。套头交易的回报率不仅在统计意义上显著大于零,而且在经济意义上也是显著的。这些结果不受不同的检验方法影响,也无法为我们所考虑到的风险因素所解释。本文的发现说明了中国的股票市场尚未达到Fama(1970)意义上的半强式有效,投资者在投资决策时可以利用分析师的盈利预测以提高其投资的回报。此外,本文的结果也有助于回答中国的财务分析师是否具有专业胜任能力这一颇有争议的问题。     

Stock returns,aggregate earnings surprises,and behavioral finance

We study the stock market's reaction to aggregate earnings news. Prior research shows that, for individual firms, stock prices react positively to earnings news but require several quarters to fully reflect the information in earnings. We find a substantially different pattern in aggregate data. First, returns are unrelated to past earnings, suggesting that prices neither underreact nor overreact to aggregate earnings news. Second, aggregate returns correlate negatively with concurrent earnings; over the last 30 years, for example, stock prices increased 5.7% in quarters with negative earnings growth and only 2.1% otherwise. This finding suggests that earnings and discount rates move together over time and provides new evidence that discount-rate shocks explain a significant fraction of aggregate stock returns.     

Value relevance of international accounting standards harmonization: Evidence from A- and B-share markets in China

Applying both the price-levels model and the lagged-price-deflated returns model, we investigated the incremental value relevance of the reconciliation of accounts from the Chinese Accounting Standards (CAS) to the International Accounting Standards (IAS) by those Chinese listed companies that have simultaneously issued A-shares and B-shares. In addition, we examined the usefulness of accounting numbers (earnings and book values) and their value relevance to the A- and B-share markets in China. The study finds that earnings and book values of owners’ equity determined under CAS are more relevant accounting information for the purpose of determining the prices of A- and B-shares. The CAS-based earnings changes were reflected in stock returns in the B-share market, while the CAS-based earnings were closely associated with stock returns in the A-share market. However, the study found that the reconciliation of earnings and book values from CAS to IAS basis is partially value-relevant, mainly to stock prices in the B-share market, while the earnings reconciliation is generally not value-added to stock returns in either the A- or the B-share market. The study results suggest that accounting numbers based on domestic accounting standards, in contrast to IAS, are more value-relevant in the Chinese stock market at present.     

Portfolio performance and accounting measures of earnings: an alternative look at usefulness

Measures of economic performance, such as accounting earnings, working capital and cash flows, have been evaluated in tests of relative explanatory power of regressions of market returns on earnings, working capital and cash flows. We employ a different test. Using Basu’s (J Finance 663–682, 1977) investment trading strategy, we measure portfolio returns based on these three accounting measures of earnings. The objective is to ascertain whether investment performance also supports the findings of the explanatory power studies that accounting earnings is the premier measure of performance. The evidence does not support this conclusion. Our findings are at variance with prior conclusions that accounting earnings is more useful than cash flow. The Basu trading strategy is effective for all three measures. Excess market returns are observed for all three measures, even when controlled for risk and for low priced stocks. But accounting earnings portfolios do not dominate working capital or cash flow portfolios. In fact, the raw returns to cash flow portfolios are marginally (statistically) larger than accounting earnings portfolios. Economically, a dollar invested in a portfolio using accounting earnings to select the stock would have an accumulated value of 22.73 while the same dollar investment using cash flow instead of accounting earnings would accumulate a value of22.73 while the same dollar investment using cash flow instead of accounting earnings would accumulate a value of 33.94 over the same 16 years starting with the second quarter of 1988 and concluding at the end of the first quarter of 2004. Thus, our results have implications for the studies of explanatory power of different measures of earnings and their comparison in the US and other markets.     

Funding conditions and insurance stock returns: Do insurance stocks really benefit from rising interest rate regimes?

We examine funding conditions and U.S. insurance company stock returns. Although constrained funding conditions, signaled by restrictive Federal Reserve monetary policy, correspond with increases in the future payouts of fixed‐income securities held by insurance firms and potentially provide value through the liability side of insurer balance sheets, they also decrease the values of securities currently held in insurer portfolios. Prior research finds that restrictive policy has a negative effect on equity returns in general. Our results suggest the negative impacts of constrained funding environments outweigh the potential positives, as insurance company stock returns are significantly lower during periods of constrained funding. This effect varies within a given funding state and also across insurer type. The effect is strongest during the first 3 months of a constrained funding environment and for life and health insurers—insurer types with longer portfolio durations. For property and liability (P&L) insurers, lower stock return performance only exists in the first 3 months of a constrained funding environment. In the subsequent months, P&L insurers actually have higher stock returns during constrained periods, consistent with their typically shorter duration asset portfolios, which are more quickly rolled over into new higher‐yielding securities.     

Computerized stock screening rules for portfolio selection

Recent studies have uncovered several systematic patterns that increase the probability that individual investors can select stock portfolios with excess returns. This study tests the feasibility of using a commercially available computerized stock screening program for investors to take advantage of these patterns. The screening program searches the three major exchanges and selects stocks on both fundamental and technical indicators: low price-to-sales ratio, small firm size, accelerating stock prices above their 50 day moving average, high trading volume, and high earnings growth. Of the 18 models tested between 1994 and 1998, those that allow for selection between exchanges yield portfolio returns that significantly exceed the average market indices.     

Analysts’ Momentum Recommendations

We document that the likelihood of analyst recommendations following past stock returns decreased abruptly in 2003, coinciding with the Global Settlement and other regulatory changes designed to restrain analysts’ conflicts of interest. We also document that the likelihood of recommendations following past stock returns is abnormally high for recommendations issued after negative stock returns (but not for those issued after positive stock returns), among inexperienced and inaccurate analysts, among large brokerage houses, and for companies with high share turnover. Moreover, the recommendations that are more likely to follow past stock returns are accompanied by earnings forecast revisions that are larger in magnitude and less accurate ex post. Overall, our findings suggest that analysts with conflicts of interest and limited ability are more likely to base their recommendations on past stock returns. Finally, we document that the recommendations that are more likely to follow past stock returns (especially those that were issued before 2003 and those that are issued after negative stock returns) contribute to existing price momentum by generating incrementally stronger short‐term and long‐term stock returns.     

Book Assets,Real Estate,and Returns on Common Stock

Since real estate is common to most firms, this study examines whether there is a real estate factor in common stock returns that is not completely captured by existing asset pricing models. The three-factor model of Fama and French (1993), hereafter FF, is extended to incorporate a unique real estate factor. Using his extended-FF model, we examine the returns on 53 industry portfolios of common stocks over the 1972 through 1995 time period. The results indicate that a significant 19 percent of the industries are systematically related to the real estate factor. Most interestingly, we show that the loading of the real estate factor in common stock return is related to the loading of the book-to-market equity factor in these returns. We also construct decile portfolios of common stocks based on historical sensitivities of common stock returns to the real estate factor. The coefficients on the real estate factor vary systematically across the decile portfolios. The results of our analysis suggest that portfolio managers should manage their exposure to real estate.     

A Time-Series Model of Stock Returns with a Positive Short-Term Correlation and a Negative Long-Term Correlation

We study portfolio stock return behavior that exhibits both a positive autocorrelation over short horizons and a negative autocorrelation over long horizons. These autocorrelations are more significant in small size portfolios. Among various forms of temporary components in stock prices, an AR(2) component is the simplest model compatible with this pattern of returns, which yields an ARMA(2,2) model of stock returns. We show that the significance of this model is that it requires the presence of feedback trading, which is a form of irrational trades, and the market's slow adjustment to the market fundamentals, which is consistent with recent modelings of stock prices. We find that the variation of the temporary component becomes greater as the firm size gets smaller. This implies that the deviation from the market fundamentals is larger in small size portfolios than in large size portfolios.     

The negative news threshold—An explanation for negative skewness in stock returns

Abstract

A vast literature documents negative skewness in stock index return distributions on several markets. In this paper the issue of negative skewness is approached from a different angle to previous studies by combining the Trueman's 1997 model of management disclosure practices with symmetric market responses in order to explain negative skewness in stock returns. Empirical tests reveal that returns for days when non-scheduled news items are disclosed are the source of negative skewness in stock returns, as predicted. These findings suggest that negative skewness in stock returns is induced by asymmetries in the news disclosure policies of firm management. Furthermore, it is found that the returns are negatively skewed only for non-scheduled firm-specific news disclosures for firms where the management is compensated with stock options.     

Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth

A growing body of literature in accounting and finance relies on implied cost of equity (COE) measures. Such measures are sensitive to assumptions about terminal earnings growth rates. In this paper we develop a new COE measure that is more accurate than existing measures because it incorporates endogenously estimated long-term growth in earnings. Our method extends Easton et al. (J Account Res, 40, 657–676, 2002) method of simultaneously estimating sample average COE and growth. Our method delivers COE (growth) estimates that are significantly positively associated with future realized stock returns (future realized earnings growth). Moreover, the predictive ability of our COE measure subsumes that of other commonly used COE measures and is incremental to commonly used risk characteristics. Our implied growth measure fills the void in the earnings forecasting literature by robustly predicting earnings growth beyond the five-year horizon.     

Hierarchical Determinants of Brazilian Stock Returns During the 2008 Financial Crisis

Abstract:

We analyze the influence of firm- and industry-level determinants on stock returns during the 2008 financial crisis, using a hierarchical linear model to analyze the returns of 135 Brazilian firms. The impact of these determinants on stock returns has not received sufficient attention in periods of severe market decline. The following determinants were significant: (1) industry-level determinants (unlevered beta, historical sales growth, and regulated tariff), and (2) firm-level determinants (size, illiquidity, and book-to-market ratio). We also identified an indirect influence of unlevered beta over book-to-market that reflects a behavior that we call the “misconfidence effect.”     

Inflation Illusion and Post-Earnings-Announcement Drift

This paper examines the cross‐sectional implications of the inflation illusion hypothesis for the post‐earnings‐announcement drift. The inflation illusion hypothesis suggests that stock market investors fail to incorporate inflation in forecasting future earnings growth rates, and this causes firms whose earnings growths are positively (negatively) related to inflation to be undervalued (overvalued). We argue and show that the sensitivity of earnings growth to inflation varies monotonically across stocks sorted on standardized unexpected earnings (SUE) and, consistent with the inflation illusion hypothesis, show that lagged inflation predicts future earnings growth, abnormal returns, and earnings announcement returns of SUE‐sorted stocks. Interestingly, controlling for the return predictive ability of inflation weakens the ability of lagged SUE to predict future returns of SUE‐sorted stocks.     

Is Economic Growth Good for Investors?1

When measured over long periods of time, the correlation of countries' inflation‐adjusted per capita GDP growth and stock returns is negative. This result holds for both developed countries (for which the correlation coefficient is –0.39 using data from 1900–2011) and emerging markets (the correlation is –0.41 over the period 1988–2011). And this means that investors would have been better off investing in countries with lower per capita GDP growth than in countries experiencing the highest growth rates. This seems surprising since economic growth is generally assumed to be good for corporate profits. In attempting to explain this finding, the author begins by noting that economic growth can be achieved through increased inputs of capital and labor, which don't necessarily benefit the stockholders of existing companies. Growth also comes from technological advances, which do not necessarily lead to higher profits since competition among firms often results in the benefits accruing to consumers and workers. What's more, it's important to recognize that growth has both an expected and an unexpected component. And one explanation for the negative correlation between growth and stock returns is the tendency for investors to overpay for expected growth. But there is another—and in the author's view, a more important—part of the explanation. Along with the negative correlation between long‐run average stock returns and per capita growth rates, the author also reports a strong positive association between (per share) dividend growth rates and overall stock returns. Such an association is not surprising since unusual growth in dividends is a fairly reliable predictor of increases in future earnings. But another effect at work here is the role of dividends—and, in the U.S., stock repurchases too—in limiting what might be called the corporate “overinvestment problem,” the natural tendency of corporate managers to pursue growth, if necessary at the expense of profitability. One of the main messages of this article is that corporate growth adds value only when companies reinvest their earnings in projects that are expected to earn at least their cost of capital—while at the same time committing to return excess cash and capital to their shareholders through dividends and stock buybacks.     

Forecasting Japanese Stock Returns with Financial Ratios and Other Variables

This paper extends the previous analyses of the forecastability of Japanese stock market returns in two directions. First, we carefully construct smoothed market price–earnings ratios and examine their predictive ability. We find that the empirical performance of the price–earnings ratio in forecasting stock returns in Japan is generally weaker than both the price–earnings ratio in comparable US studies and the price dividend ratio. Second, we also examine the performance of several other forecasting variables, including lagged stock returns and interest rates. We find that both variables are useful in predicting aggregate stock returns when using Japanese data. However, while we find that the interest rate variable is useful in early subsamples in this regard, it loses its predictive ability in more recent subsamples. This is because of the extremely limited variability in interest rates associated with operation of the Bank of Japan’s zero interest policy since the late 1990s. In contrast, the importance of lagged returns increases in subsamples starting from the 2000s. Overall, a combination of logged price dividend ratios, lagged stock returns, and interest rates yield the most stable performance when forecasting Japanese stock market returns.     

Risk,Mispricing, and Value Investing

We evaluate the stock return performance of a modified version of the book-to-market strategy and its implications for market efficiency. If the previously documented superior stock return of the book-to-market strategy represents mispricing, its performance should be improved by excluding fairly valued firms with extreme book-to-market ratios. To attain this, we classify stocks as value or glamour on book-to-market ratios and accounting accruals jointly. This joint classification is likely to exclude stocks with extreme book-to-market ratios due to mismeasured accounting book values reflecting limitations underlying the accounting system. Using both 12-month buy-and-hold returns and earnings announcement returns, our results show that this joint classification generates substantially higher portfolio returns in the post-portfolio-formation year than the book-to-market classification alone with no evidence of increased risk. In addition, this superior stock return performance is more pronounced among firms held primarily by small (unsophisticated) investors and followed less closely by market participants (stock price <$10). Finally, and most importantly, financial analysts are overly optimistic (pessimistic) about earnings of glamour (value) stock, and for a subset of firms identified as overvalued by our strategy, the earnings announcement raw return, as well as abnormal return, is negative. These last results are particularly important because it is hard to envision a model consistent with rational investors holding risky stocks with predictable negative raw returns for a long period of time rather than holding fT-bills and with financial analysts systematically overestimating the earnings of these stocks while underestimating earnings of stocks that outperform the stock market.