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Aggregate Earnings, Firm-Level Earnings, and Expected Stock Returns

Published online by Cambridge University Press:  06 April 2009

Turan G. Bali ,
K. Ozgur Demirtas  and
Hassan Tehranian
Turan G. Bali
Affiliation:
turan bali@baruch.cuny.edu, and ozgur demirtas@baruch.cuny.edu, Department of Economics and Finance, Zicklin School of Business, Baruch College, City University of New York, One Bernard Baruch Way, Box 10–225, New York, NY 10010 and College of Administrative Sciences and Economics, Koc University, Rumeli Feneri Yolu, Sariyer, Istanbul 34450, Turkey
K. Ozgur Demirtas
Affiliation:
turan bali@baruch.cuny.edu, and ozgur demirtas@baruch.cuny.edu, Department of Economics and Finance, Zicklin School of Business, Baruch College, City University of New York, One Bernard Baruch Way, Box 10–225, New York, NY 10010 and College of Administrative Sciences and Economics, Koc University, Rumeli Feneri Yolu, Sariyer, Istanbul 34450, Turkey
Hassan Tehranian
Affiliation:
hassan.tehranian@bc.edu, Department of Finance, Carroll School of Management, Boston College, Fulton Hall 324C, Chestnut Hill, MA 02167.
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Abstract

This paper provides an analysis of the predictability of stock returns using market-, industry-, and firm-level earnings. Contrary to Lamont (1998), we find that neither dividend payout ratio nor the level of aggregate earnings can forecast the excess market return. We show that these variables do not have robust predictive power across different stock portfolios and sample periods. In contrast to the aggregate-level findings, earnings yield has significant explanatory power for the time-series and cross-sectional variation in firmlevel stock returns and the 48 industry portfolio returns. The mean reversion of stock prices as well as the earnings' correlation with expected stock returns are responsible for the forecasting power of earnings yield. These results are robust after controlling for bookto-market, size, price momentum, and post-earnings announcement drift. At the aggregate level, the information content of firm-level earnings about future cash flows is diversified away and higher aggregate earnings do not forecast higher returns.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 43 , Issue 3 , September 2008 , pp. 657 - 684
Copyright
Copyright © School of Business Administration, University of Washington 2008

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