Accounting Ratios and the Cross‐section of Expected Stock Returns

Under clean‐surplus accounting, the log return on a stock can be decomposed into a linear function of the contemporaneous log return on equity, the contemporaneous log dividend–price ratio (if the stock pays a dividend), and both the contemporaneous and lagged values of the log book‐to‐market equity ratio. This paper studies the implications of this decomposition for the cross‐section of conditional expected stock returns. The empirical analysis reveals that the log accounting ratios capture cross‐sectional variation in both the conditional mean and conditional variance of log stock returns, which is consistent with the decomposition. It also brings fresh insights to the relation between firm size (market equity) and conditional expected stock returns. The evidence indicates that the conditional median return increases with firm size, while the conditional return skewness decreases with firm size. Empirically, the skewness effect outweighs the median effect, leading to the well‐documented inverse relation between size and average returns. The results of out‐of‐sample tests suggest that investors could use the information provided by the observed values of the log accounting ratios to formulate more effective portfolio strategies.     

Dividend Stability, Dividend Yield and Stock Returns: UK Evidence

This paper establishes an empirical role for two measures of dividend stability (as a proxy for dividend policy) in explaining UK stock returns. There is little systematic empirical evidence concerning the relation between dividend stability, dividend yield and stock returns despite the fact that a variety of theoretical models point to dividend policy as an important stock attribute. Here we construct two definitions of dividend stability, one of which involves dividend cuts, and use a sample of all listed UK firms from 1975 to 1997 to explore the relationship between stock returns and a variety of characteristics, including dividend stability. We find an inverse correlation between the stability of past dividend policy and systematic risk. Both stability measures have explanatory power over returns, but this is concentrated in January.     

Dividend Stability, Dividend Yield and Stock Returns: UK Evidence

This paper establishes an empirical role for two measures of dividend stability (as a proxy for dividend policy) in explaining UK stock returns. There is little systematic empirical evidence concerning the relation between dividend stability, dividend yield and stock returns despite the fact that a variety of theoretical models point to dividend policy as an important stock attribute. Here we construct two definitions of dividend stability, one of which involves dividend cuts, and use a sample of all listed UK firms from 1975 to 1997 to explore the relationship between stock returns and a variety of characteristics, including dividend stability. We find an inverse correlation between the stability of past dividend policy and systematic risk. Both stability measures have explanatory power over returns, but this is concentrated in January.     

Stock returns,dividend yield,and book-to-market ratio

A dividend yield model has been widely used in previous research that relates stock market valuations to cash flow fundamentals. Given controversies about using dividends as a proxy for cash flows, a loglinear book-to-market model has recently been proposed. However, these models rely on the assumption that dividend yield and book-to-market ratio are both stationary, and empirical evidence for this is, at best, mixed. We develop a new model, the loglinear cointegration model, that explains future profitability and excess stock returns in terms of a linear combination of log book-to-market ratio and log dividend yield. The loglinear cointegration model performs better than the log dividend yield model and the log book-to-market model in terms of cross-equation restriction tests and forecasting performance comparisons. The superior performance of the loglinear cointegration model suggests that the linear combination may be a better indicator of intrinsic fundamentals than the dividend yield or the book-to-market ratio separately.     

A Dividend Payment Effect in Stock Returns

This paper presents evidence for the period 7/62-12/89 that individual NYSE and AMEX stocks provide relatively high average excess returns on the payment dates of quarterly cash dividends and several subsequent trading days. Additional results indicate that returns during the payment period: (a) are not a manifestation of the January, monthly or dividend yield anomalies; (b) are positively related to the stock's dividend yield; and (c) are higher for firms that have dividend reinvestment plans. These findings are consistent with a tendency by stock-holders to reinvest dividend income into the stock of the paying firm, thereby increasing demand for the stock and raising its price. Additional evidence links the returns on these days with (previously-documented) excess returns around the ex-dividend date.     

The effects of dividend yield and dividend policy on common stock prices and returns

This paper suggests that it is not possible to demonstrate, using the best available empirical methods, that the expected returns on high yield common stocks differ from the expected returns on low yield common stocks either before or after taxes. A taxable investor who concentrates his portfolio in low yield securities cannot tell from the data whether he is increasing or decreasing his expected after-tax return by so doing. A tax exempt investor who concentrates his portfolio in high yield securities cannot tell from the data whether he is increasing or decreasing his expected return. We argue that the best method for testing the effects of dividend policy on stock prices is to test the effects of dividend yield on stock returns. Thus the fact that we cannot tell, using the best available methods, what effects dividend yield has on stock returns implies that we cannot tell what effect, if any, a change in dividend policy will have on a corporation's stock price.     

THE INFORMATION CONTENT OF DIVIDEND CHANGES

In this study, the open empirical question as to whether or not dividends contain information is investigated. The study involves 200 stocks and 376 dividend announcements over the 1971 to 1977 period; measures of unexpected dividends are related to measures of abnormal returns for dividend changing stocks. This study is important for three reasons:

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The Gilt-Equity Yield Ratio and the Predictability of UK and US Equity Returns

A number of financial variables have been shown to be effective in explaining the time-series of aggregate equity returns in both the UK and the US. These include, inter alia , the equity dividend yield, the spread between the yields on long and short government bonds, and the lagged equity return. Recently, however, the ratio between the long government bond yield and the equity dividend yield – the gilt-equity yield ratio – has emerged as a variable that has considerable explanatory power for UK equity returns. This paper compares the predictive ability of the gilt-equity yield ratio with these other variables for UK and US equity returns, providing evidence on both in-sample and out-of-sample performance. For UK monthly returns, it is shown that while the dividend yield has substantial in-sample explanatory power, this is not matched by out-of sample forecast accuracy. The gilt-equity yield ratio, in contrast, performs well both in-sample and out-of-sample. Although the predictability of US monthly equity returns is much lower than for the UK, a similar result emerges, with the gilt-equity yield ratio dominating the other variables in terms of both in-sample explanatory power and out-of-sample forecast performance. The gilt-equity yield ratio is also shown to have substantial predictive ability for long horizon returns.     

The Gilt-Equity Yield Ratio and the Predictability of UK and US Equity Returns

A number of financial variables have been shown to be effective in explaining the time-series of aggregate equity returns in both the UK and the US. These include, inter alia , the equity dividend yield, the spread between the yields on long and short government bonds, and the lagged equity return. Recently, however, the ratio between the long government bond yield and the equity dividend yield – the gilt-equity yield ratio – has emerged as a variable that has considerable explanatory power for UK equity returns. This paper compares the predictive ability of the gilt-equity yield ratio with these other variables for UK and US equity returns, providing evidence on both in-sample and out-of-sample performance. For UK monthly returns, it is shown that while the dividend yield has substantial in-sample explanatory power, this is not matched by out-of sample forecast accuracy. The gilt-equity yield ratio, in contrast, performs well both in-sample and out-of-sample. Although the predictability of US monthly equity returns is much lower than for the UK, a similar result emerges, with the gilt-equity yield ratio dominating the other variables in terms of both in-sample explanatory power and out-of-sample forecast performance. The gilt-equity yield ratio is also shown to have substantial predictive ability for long horizon returns.     

On the reversal of return and dividend growth predictability: A tale of two periods

A disconcerting, albeit generally accepted, finding is that aggregate stock returns are predictable by dividend yield but dividend growth is unpredictable. I show that part of this lack of dividend growth predictability stems from how dividend growth is constructed. I then show a dramatic reversal of predictability in the 134 years during 1872–2005: stock returns are largely unpredictable in the first seven decades, but become predictable in the postwar period; dividend growth is strongly predictable in the prewar years but this predictability disappears in the postwar years. New evidence on the predictability of long-run returns and dividend growth is also shown.     

Capital Gains, Dividend Yields, and Expected Inflation

One explanation for the negative relationship between short-horizon stock returns and inflation is that inflation proxies (inversely) for expected future real output. In this paper, I examine the possibility that inflation also proxies for variation in real price/dividend ratios (excess returns). I show that when the covariance between real price/dividend ratios and inflation is nonzero, the relationship between returns and expected inflation differs for the two components of returns: dividend yields and capital gains returns. My empirical evidence demonstrates that dividend yields and capital gains are related differently to expected inflation in U.S. and foreign markets.     

Importance of skewness in decision making: Evidence from the Indian stock exchange

In this paper our goal is to examine the importance of skewness in decision making, in particular on investor utility. We use time-series daily data on sectoral stock returns on the Indian stock exchange. We test for sectoral stock return predictability using commonly used financial ratios, namely, the price-to-book, dividend yield and price-earnings. We find strong evidence of predictability. Using this evidence of predictability, we forecast sectoral stock returns for each of the sectors in our sample, allowing us to devise trading strategies that account for skewness of returns. We discover evidence that accounting for skewness leads not only to higher utility compared to a model that ignores skewness, but utility is sector-dependent.     

Expected returns and expected dividend growth

We investigate a consumption-based present-value relation that is a function of future dividend growth and find that changing forecasts of dividend growth are an important feature of the post-war U.S. stock market, despite the failure of the dividend–price ratio to uncover such variation. In addition, dividend forecasts are found to covary with changing forecasts of excess stock returns over business cycle frequencies. This covariation is important because positively correlated fluctuations in expected dividend growth and expected returns have offsetting effects on the log dividend–price ratio. The market risk premium and expected dividend growth thus vary considerably more than is apparent using the log divided–price ratio alone as a predictive variable.     

Consumption, Aggregate Wealth, and Expected Stock Returns

This paper studies the role of fluctuations in the aggregate consumption–wealth ratio for predicting stock returns. Using U.S. quarterly stock market data, we find that these fluctuations in the consumption–wealth ratio are strong predictors of both real stock returns and excess returns over a Treasury bill rate. We also find that this variable is a better forecaster of future returns at short and intermediate horizons than is the dividend yield, the dividend payout ratio, and several other popular forecasting variables. Why should the consumption–wealth ratio forecast asset returns? We show that a wide class of optimal models of consumer behavior imply that the log consumption–aggregate wealth (human capital plus asset holdings) ratio summarizes expected returns on aggregate wealth, or the market portfolio. Although this ratio is not observable, we provide assumptions under which its important predictive components for future asset returns may be expressed in terms of observable variables, namely in terms of consumption, asset holdings and labor income. The framework implies that these variables are cointegrated, and that deviations from this shared trend summarize agents' expectations of future returns on the market portfolio.     

A STATE‐SPACE MODEL OF SHORT‐ AND LONG‐HORIZON STOCK RETURNS

In this article we propose a new parsimonious state‐space model in which state variables characterize the stochastic movements of stock returns. Using the equally weighted and decile monthly stock returns, we show that (a) a parsimonious state‐space model characterizes the variation in expected returns at any horizon; (b) the extracted expected returns explain a substantial proportion of the variance in realized returns, and the magnitude of this proportion increases significantly with the horizon of returns; (c) the model successfully captures the empirical fact that returns of smaller firms have both stronger positive autocorrelations of short‐horizon returns and stronger negative autocorrelations of long‐horizon returns; and (d) the forecasts of asset returns obtained with the state‐space model subsume the information in other potential predictor variables such as dividend yields. JEL classification: G10, G12.     

On the Importance of Measuring Payout Yield: Implications for Empirical Asset Pricing

We investigate the empirical implications of using various measures of payout yield rather than dividend yield for asset pricing models. We find statistically and economically significant predictability in the time series when payout (dividends plus repurchases) and net payout (dividends plus repurchases minus issuances) yields are used instead of the dividend yield. Similarly, we find that payout (net payout) yields contains information about the cross section of expected stock returns exceeding that of dividend yields, and that the high minus low payout yield portfolio is a priced factor.     

COSKEWNESS,DIVIDEND YIELD AND CAPITAL ASSET PRICING

The coskewness and dividend yield effects on capital asset prices have been established in two separate literatures. Neither literature controls for the variable in the other, nor for other potentially confounding factors such as size of the firm and the January effect on returns. Using stock return data for 1969–1978, this study provides evidence of coskewness, size, yield and January effects on stock returns. Coskewness appears to be a surrogate variable for dividend yield. When yield is controlled for, the coskewness effect cannot be detected. Hence, the significance of coskewness seems to result from the presence of the uncontrolled factor, dividend yield.     

New Evidence That Taxes Affect the Valuation of Dividends

This paper uses British data to examine the effects of dividend taxes on investors' relative valuation of dividends and capital gains. British data offer great potential to illuminate the dividends and taxes question, since there have been two radical changes and several minor reforms in British dividend tax policy during the last 30 years. Studying the relationship between dividends and stock price movements during different tax regimes offers an ideal controlled experiment for assessing the effects of taxes on investors' valuation of dividends. Using daily data on a small sample of firms, and monthly data on a much broader sample, we find clear evidence that taxes affect the equilibrium relationship between dividend yields and market returns. These findings suggest that taxes are important determinants of security market equilibrium and deepen the puzzle of why firms pay dividends.     

Corporate Governance and Expected Stock Returns: Evidence from Germany

Recent empirical work shows evidence for higher valuation of firms in countries with a better legal environment. We investigate whether differences in the quality of firm‐level corporate governance also help to explain firm performance in a cross‐section of companies within a single jurisdiction. Constructing a broad corporate governance rating (CGR) for German public firms, we document a positive relationship between governance practices and firm valuation. There is also evidence that expected stock returns are negatively correlated with firm‐level corporate governance, if dividend yields are used as proxies for the cost of capital. An investment strategy that bought high‐CGR firms and shorted low‐CGR firms earned abnormal returns of around 12% on an annual basis during the sample period.     

Stock and bond returns with Moody Investors

We present a tractable, linear model for the simultaneous pricing of stock and bond returns that incorporates stochastic risk aversion. In this model, analytic solutions for endogenous stock and bond prices and returns are readily calculated. After estimating the parameters of the model by the general method of moments, we investigate a series of classic puzzles of the empirical asset pricing literature. In particular, our model is shown to jointly accommodate the mean and volatility of equity and long term bond risk premia as well as salient features of the nominal short rate, the dividend yield, and the term spread. Also, the model matches the evidence for predictability of excess stock and bond returns. However, the stock–bond return correlation implied by the model is somewhat higher than that in the data.