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.     

Dissecting Earnings Recognition Timeliness

We dissect the portion of stock price change of the fiscal year that is recognized in reported accounting earnings of the year. We call this portion earnings recognition timeliness (ERT). The emphasis in our dissection is on empirical identification of two fundamental precepts of financial accounting: (1) the matching principle, which is manifested in the recognition of expenses in the same period as the related benefits (i.e., sales revenue) accrue; and (2) recognition of expenses in the current period due to changes in expectations regarding earnings of future periods (we refer to these expenses as the expectations element of expenses). Although the expectations element has implicitly been at the core of much of the recent empirical literature on asymmetry in the earnings/return relation, it has not been explicitly identified. This recent literature is based on the premise that bad news about the future leads to more recognition of expenses in the current period (such as write‐downs) whereas good news about the future tends to have a much lesser effect on expenses of the current period; asymmetry in the expenses/return relation is captured implicitly via the observation of asymmetry in the earnings/return relation (i.e., asymmetry in ERT). Since the ERT reflects the relation between sales revenue and returns, matched expenses and returns, as well as the relation between the expectations element of expenses and returns, a focus on the expectations element may lead to sharper inferences. Our straightforward empirical procedure permits a focus on this element.     

Does Greater Firm‐Specific Return Variation Mean More or Less Informed Stock Pricing?

Roll [1988] observes low R² statistics for common asset pricing models due to vigorous firm‐specific return variation not associated with public information. He concludes that this implies “either private information or else occasional frenzy unrelated to concrete information”[p. 56]. We show that firms and industries with lower market model R² statistics exhibit higher association between current returns and future earnings, indicating more information about future earnings in current stock returns. This supports Roll's first interpretation: higher firm‐specific return variation as a fraction of total variation signals more information‐laden stock prices and, therefore, more efficient stock markets.     

The Pricing of Relative Performance Based Incentives for Executive Compensation

Japanese firms report both parent-only and consolidated financial statements. Because of the unique business environment in Japan, there is a widely held view that parent-only data provides a better means for assessing the value of the entire firm. We find that both parent-only and subsidiary earnings are important in predicting future consolidated earnings. However, while stock prices accurately reflect the persistence of parent-only earnings, the Japanese stock market appears to underestimate the persistence of subsidiary earnings, causing a significant positive relation between changes in subsidiary earnings in year t and stock returns in year t +1. This relation between subsidiary earnings and future stock returns does not persist beyond year t 7plus;1. Taking a long (short) position in firms with large, positive (negative) changes in subsidiary earnings results in an average annual abnormal return of 7.06% with positive returns in 12 of the 13 years in the test period.     

Expectations‐Based Management

The authors begin by summarizing the results of their recently published study of the relation between stock returns and changes in several annual performance measures, including not only growth in earnings and EVA, but changes during the year in analysts' expectations about future earnings over three different periods: (1) the current year; (2) the following year; and (3) the three‐year period thereafter. The last of these measures—changes in analysts' expectations about three‐ to five‐year earnings—had by far the greatest explanatory “power” of any of the measures tested. Besides being consistent with the stock market's taking a long‐term, DCF approach to the valuation of companies, the authors' finding that investors seem to care most about earnings three to five years down the road has a number of important implications for financial management: First, a business unit doesn't necessarily create shareholder value if its return on capital exceeds the weighted average cost of capital—nor does an operation that fails to earn its WACC necessarily reduce value. To create value, the business's return must exceed what investors are expecting. Second, without forecasting returns on capital, management should attempt to give investors a clear sense of the firm's internal benchmarks, both for existing businesses and new investment. Third, management incentive plans should be based on stock ownership rather than stock options. Precisely because stock prices reflect expectations, the potential for prices to get ahead of realities gives options‐laden managers a strong temptation to manipulate earnings and manage for the short term.     

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.     

Expectations and the Cross-Section of Stock Returns

Previous research has shown that stocks with low prices relative to book value, cash flow, earnings, or dividends (that is, value stocks) earn high returns. Value stocks may earn high returns because they are more risky. Alternatively, systematic errors in expectations may explain the high returns earned by value stocks. I test for the existence of systematic errors using survey data on forecasts by stock market analysts. I show that investment strategies that seek to exploit errors in analysts' forecasts earn superior returns because expectations about future growth in earnings are too extreme.     

Good News for Value Stocks: Further Evidence on Market Efficiency

This article examines the hypothesis that the superior return to so-called value stocks is the result of expectational errors made by investors. We study stock price reactions around earnings announcements for value and glamour stocks over a 5-year period after portfolio formation. The announcement returns suggest that a significant portion of the return difference between value and glamour stocks is attributable to earnings surprises that are systematically more positive for value stocks. The evidence is inconsistent with a risk-based explanation for the return differential.     

THE SIZE EFFECT IS PRIMARILY A PRICE EFFECT

Previous research shows that stock returns are related to firm market value and earnings yield. This study decomposes the measurements of market value and earnings yield into separate components (share price and shares outstanding for market value, earnings per share and share price for earnings yield) and examines the relationship between stock return and these components. Share price represents approximately three-fourths of the relationship between stock returns and either market value or earnings yield. Potential causes for this phenomenon are advanced.     

Is the decline in the value relevance of accounting driven by increased conservatism?

This paper examines the association between conservatism and the value relevance of accounting information over the 1975 through 2004 period. We measure conservatism using approaches developed in Penman and Zhang, The Accounting Review 77:237–264, (2002) and Beaver and Ryan, Journal of Accounting Research 38:127–148, (2000) and value relevance using (1) adjusted R ² from regressions of price on earnings and book values, (2) adjusted R ² from regressions of returns on earnings and changes in earnings, and (3) returns earned by perfect foresight of earnings and book values. We find no evidence that firms with increasing conservatism exhibit greater declines in value relevance. Rather, we observe most significant declines in value relevance for firms where conservatism has not increased. When we adjust financial statements for the effects of conservatism, we find that the value relevance of adjusted numbers is generally lower and trends in value relevance unaffected. Based on these results, it is implausible that increasing conservatism drives the decline in value relevance.     

An Analysis of the Relation between the Stewardship and Valuation Roles of Earnings

In this paper, we seek a deeper understanding of how accounting information is used for valuation and incentive contracting purposes. We explore linkages between weights on earnings in compensation contracts and in stock price formation. A distinction between the valuation and incentive contracting roles of earnings in Paul [1992] produces the null hypothesis that valuation earnings coefficients (VECs) and compensation earnings coefficients (CECs) are unrelated. Our empirical analyses of the relations between earnings and both stock prices and executive compensation data at the firm and industry levels over the period 1971–2000 rejects Paul's [1992] hypothesis of no relation. We also document an increasing weight over time on other public performance information captured by stock returns in the determination of cash compensation. Specifically, we find that the incentive coefficient on returns is significantly higher in the second of two equal sample subperiods relative to the incentive coefficient on earnings.     

剩余收益模型与股票未来回报

本文采用Hou et al.(2012)公司基本面盈余预测模型并结合剩余收益模型对上市公司的内在价值进行估计,并分析内在价值与市价比率(V/P)与股票未来回报之间的关系。我们发现基于V/P分组的投资组合,在未来一至三年规模调整的持有超额回报套利分别达到15.2%、37.9%和55.9%;在控制了市账比等因素以后,V/P对股票未来回报仍然具有显著的预测作用。本文的研究克服了以往文献中运用证券分析师盈余预测进行剩余收益模型估值的内在局限,并提供了我国资本市场背景下切实可行的基于剩余收益模型估值的投资组合策略。     

How Much New Information Is There in Earnings?

We quantify the relative importance of earnings announcements in providing new information to the share market, using the R² in a regression of securities' calendar‐year returns on their four quarterly earnings‐announcement “window” returns. The R², which averages approximately 5% to 9%, measures the proportion of total information incorporated in share prices annually that is associated with earnings announcements. We conclude that the average quarterly announcement is associated with approximately 1% to 2% of total annual information, thus providing a modest but not overwhelming amount of incremental information to the market. The results are consistent with the view that the primary economic role of reported earnings is not to provide timely new information to the share market. By inference, that role lies elsewhere, for example, in settling debt and compensation contracts and in disciplining prior information, including more timely managerial disclosures of information originating in the firm's accounting system. The relative informativeness of earnings announcements is a concave function of size. Increased information during earnings‐announcement windows in recent years is due only in part to increased concurrent releases of management forecasts. There is no evidence of abnormal information arrival in the weeks surrounding earnings announcements. Substantial information is released in management forecasts and in analyst forecast revisions prior (but not subsequent) to earnings announcements.     

Twitter investor sentiment and corporate earnings announcements

We examine the impact of firm-specific investor sentiment (FSIS) on stock returns for negative and positive earnings surprises. Using a measure constructed from firm-specific tweets, we find that FSIS has a greater impact on stock returns for negative relative to positive earnings surprises. We further show that the impact of FSIS is greater for firms whose valuation is uncertain and difficult to arbitrage. Moreover, we provide evidence of return reversals over post-announcement periods. Our results highlight the importance of FSIS around earnings announcements.     

Value-relevance of pension transition adjustments and other comprehensive income components in the adoption year of SFAS No. 158

In the present study, we examine the value-relevance of pension transition adjustments and other comprehensive income (OCI) components in the initial adoption year of Statement of Financial Accounting Standard (SFAS) 158—Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. Using a sample of 697 Standard and Poor (S&P) firms with the fiscal year ending on December 31, 2006, we perform several cross-sectional regression analyses to test the value-relevance of transition adjustments and OCI components in presence of various earnings measures. The results indicate that there is a negative relationship between both the level and change in stock returns and the magnitude of pension transition adjustments. We also find earnings measures and some OCI components are significantly associated with stock returns. When analyzed separately, we find our main results are mostly confined to the sample large S&P 500 firms. We do not find any result for the S&P mid-cap and small-cap firms. The overall results suggest the stock market negatively reacts to the adverse impact of SFAS #158 pension transition adjustments on net worth and future cash flows when the impact is substantial in its magnitude in dollar terms. The study further provides useful insight into the information processing by documenting that the market evaluates accounting information more effectively when such information is recognized in the financial statements rather than disclosed only in the financial footnotes.     

Stockholders’ Unrealized Returns and the Market Reaction to Financial Disclosures

Using both investor‐ and stock‐level data, I examine the relation between stockholders’ unrealized returns since purchase and the market response to earnings announcements. I demonstrate that stockholders’ unrealized gain/loss position moderates their trading behavior in response to earnings announcements. I also find that this behavior generates a short‐window return underreaction to earnings news. My results are generally consistent with predictions from prospect theory regarding the manner in which stockholders’ unrealized returns moderate their trading response to belief shocks. However, my results also suggest that an emotional component (i.e., regret‐avoidance/pride‐seeking) is necessary to explain the observed investor behavior.     

The Predictive Ability of Dividend and Earnings Yields for Long-Term Stock Returns

We use empirical models to examine the predictive ability of dividend and earnings yields for long‐term stock returns. Results show that dividend and earnings yields share a similar predictive power for future stock returns and growth. We find that the predictive power of dividend yields increases with the return horizon, but that yields forecast future returns and growth over a much longer horizon. Finally, dividend and earnings yields exhibit high autocorrelation and strong contemporaneous relations.     

An examination of Value Line’s long-term projections

Unlike previous papers, which have focused on the timeliness ranks, we examine Value Line’s 3–5 year projections for stock returns, earnings, sales and related measures. We find that Value Line’s stock return and earnings forecasts exhibit large positive bias, although their sales predictions do not. For stock returns, Value Line’s projections lack predictive power; for other variables predictive power may exist to some degree. Our findings suggest the spectacular past performance of the timeliness indicator reflects either close alignment with other known anomalies or data mining, and that investors and researchers should use Value Line’s long-term projections with caution.     

The Comovement of US and UK Stock Markets

US and UK stock returns are highly positively correlated over the period 1918–99. Using VAR‐based variance decompositions, we investigate the nature of this comovement. Excess return innovations are decomposed into news about future dividends, real interest rates, and excess returns. We find that the latter news component is the most important in explaining stock return volatility in both the USA and the UK and that stock return news is highly correlated across countries. This is evidence against Beltratti and Shiller's (1993) finding that the comovement of US and UK stock markets can be explained in terms of a simple present value model. We interpret the comovement as indicating that equity premia in the two countries are hit by common real shocks.     

Estimating the Intertemporal Risk–Return Tradeoff Using the Implied Cost of Capital

We argue that the implied cost of capital (ICC), computed using earnings forecasts, is useful in capturing time variation in expected stock returns. First, we show theoretically that ICC is perfectly correlated with the conditional expected stock return under plausible conditions. Second, our simulations show that ICC is helpful in detecting an intertemporal risk–return relation, even when earnings forecasts are poor. Finally, in empirical analysis, we construct the time series of ICC for the G–7 countries. We find a positive relation between the conditional mean and variance of stock returns, at both the country level and the world market level.