Aggregate Earnings, Firm-Level Earnings and Expected Stock Returns

48 Pages Posted: 18 Jul 2009 Last revised: 27 Feb 2012

See all articles by Turan G. Bali

Turan G. Bali

Georgetown University - McDonough School of Business

K. Ozgur Demirtas

Sabanci University Graduate School of Management

Hassan Tehranian

Boston College - Department of Finance

Date Written: 2008

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 firm-level stock returns and 48-industry portfolio returns. It is the mean-reversion of stock prices as well as the earnings' correlation with expected stock returns that are responsible for the forecasting power of earnings yield. These results are robust after controlling for book-to-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.

Keywords: earnings, dividends, stock returns, market returns, predictability, business cycle

JEL Classification: G10, G12, G14

Suggested Citation

Bali, Turan G. and Demirtas, K. Ozgur and Tehranian, Hassan, Aggregate Earnings, Firm-Level Earnings and Expected Stock Returns (2008). Journal of Financial and Quantitative Analysis (JFQA), Vol. 43, No. 3, pp. 657-684, 2008, Available at SSRN: https://ssrn.com/abstract=1434355

Turan G. Bali (Contact Author)

Georgetown University - McDonough School of Business ( email )

3700 O Street, NW
Washington, DC 20057
United States
(202) 687-5388 (Phone)
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HOME PAGE: https://sites.google.com/a/georgetown.edu/turan-bali

K. Ozgur Demirtas

Sabanci University Graduate School of Management ( email )

Sabanci University, School of Management
Orhanli Tuzla
Orhanlı-Tuzla, Istanbul, 34956
Turkey
(+90) 216-483-9985 (Phone)
(+90) 216-483-9699 (Fax)

Hassan Tehranian

Boston College - Department of Finance ( email )

Carroll School of Management
140 Commonwealth Avenue
Chestnut Hill, MA 02467-3808
United States
617-552-3944 (Phone)
617-552-0431 (Fax)

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