Abstract

http://ssrn.com/abstract=2370686
 


 



It’s All About the (Return On) Book: An Answer to Why Implied Cost of Equity Capital Estimates Do Not Predict Stock Returns


Stephannie Larocque


University of Notre Dame - Mendoza College of Business

Matthew R. Lyle


Kellogg School of Management

March 12, 2015


Abstract:     
This study shows why popular proxies for expected rates of return, implied cost of equity capital (ICC) estimates, have weak associations with future stock returns: they have weak associations with future return on book equity. We are able show this because expected rates of equity returns can be parsimoniously expressed as the book-to-market ratio (BM) plus cumulative future expected return on book equity (ROE). Thus an effective ICC metric, which is intended to proxy for a firm’s expected rate of return, should be associated with both the firm’s BM and future ROE. While we do find that all ICC estimates are positively correlated with BM, no ICC estimate has a reliable positive association with future ROE after controlling for lagged ROE. Moreover, we find no evidence that any commonly used ICC estimate contains incremental information about future stock returns that is not already contained in two easily measured variables: BM and lagged ROE.

Number of Pages in PDF File: 45

Keywords: cost of capital; expected returns; ROE


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Date posted: December 22, 2013 ; Last revised: March 24, 2015

Suggested Citation

Larocque, Stephannie and Lyle, Matthew R., It’s All About the (Return On) Book: An Answer to Why Implied Cost of Equity Capital Estimates Do Not Predict Stock Returns (March 12, 2015). Available at SSRN: http://ssrn.com/abstract=2370686 or http://dx.doi.org/10.2139/ssrn.2370686

Contact Information

Stephannie A. Larocque (Contact Author)
University of Notre Dame - Mendoza College of Business ( email )
Mendoza College of Business
Notre Dame, IN 46556-5646
United States
Matthew R. Lyle
Kellogg School of Management ( email )
2001 Sheridan Road
Evanston, IL 60208
United States
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