Predicting Stock Returns in a Cross-Section: Do Individual Firm Characteristics Matter?

FINANCIAL MARKETS: RISK, VOLATILITY AND FUTURE, F. Columbus, ed., New York: Nova Science Publishers, Forthcoming

20 Pages Posted: 17 Jun 2009

See all articles by Kateryna Shapovalova

Kateryna Shapovalova

Université Paris I Panthéon-Sorbonne; Paris School of Economics (PSE)

Alexander Subbotin

Renaissance Finance

Date Written: June 17, 2009

Abstract

It is a common wisdom that individual stocks' returns are difficult to predict, though in many situations it is important to have such estimates at our disposal. In particular, they are needed to determine the cost of capital. Market equilibrium models posit that expected returns are proportional to the sensitivities to systematic risk factors. Fama and French (1993) three-factor model explains the stock returns premium as a sum of three components due to different risk factors: the traditional CAPM market beta, and the betas to the returns on two portfolios, "Small Minus Big" (the differential in the stock returns for small and big companies) and "High Minus Low" (the differential in the stock returns for the companies with high and low book-to-price ratio). The authors argue that this model is sufficient to capture the impact on returns of companies' accounting fundamentals, such as earnings-to-price, cash flow-to-price, past sales growth, long term and short-term past earnings. Using a panel of stock returns and accounting data from 1979 to 2008 for the companies listed on NYSE, we show that this is not the case, at least at individual stocks' level. According to our findings, fundamental characteristics of companies' performance are of higher importance to predict future expected returns than sensitivities to the Fama and French risk factors. We explain this finding within the rational pricing paradigm: contemporaneous accounting fundamentals may be better proxies for the future sensitivity to risk factors, than the historical covariance estimates.

Keywords: accounting funadamentals, equity performance, style analysis, value and growth, cost of capital

JEL Classification: E44, G11, E32

Suggested Citation

Shapovalova, Kateryna and Subbotin, Alexander, Predicting Stock Returns in a Cross-Section: Do Individual Firm Characteristics Matter? (June 17, 2009). FINANCIAL MARKETS: RISK, VOLATILITY AND FUTURE, F. Columbus, ed., New York: Nova Science Publishers, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1421053

Kateryna Shapovalova (Contact Author)

Université Paris I Panthéon-Sorbonne ( email )

17, rue de la Sorbonne
Paris, IL 75005
France

Paris School of Economics (PSE) ( email )

48 Boulevard Jourdan
Paris, 75014 75014
France

Alexander Subbotin

Renaissance Finance ( email )

9, chemin Pierre de Ronsard
Courbevoie, 92400
France

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