Stock Returns and the Miller-Modigliani Valuation Formula: Revisiting the Fama-French Analysis

24 Pages Posted: 6 Apr 2011 Last revised: 27 Jun 2012

See all articles by Gil Aharoni

Gil Aharoni

University of Melbourne; Financial Research Network (FIRN)

Bruce D. Grundy

University of Melbourne

Qi Zeng

University of Melbourne - Department of Finance; Financial Research Network (FIRN)

Date Written: June 19, 2012

Abstract

Abstract Fama and French (2006) use the dividend discount model to develop the joint role of three variables – expected profitability, expected investment and current BM – in predicting future stock returns. One reported empirical result is anomalous. The valuation model establishes that the comparative static relation between returns and expected investment is negative, yet it appears to be positive and insignificant. We show that the posited valuation relations between expected returns and the three variables apply at the firm level, and not at the per-share level at which they were tested. Once the variables are measured at the firm level, all the Fama-French predictions are validated.

Keywords: Book to market, profitability, investment, expected return

JEL Classification: G12 G32

Suggested Citation

Aharoni, Gil and Grundy, Bruce D. and Zeng, Qi, Stock Returns and the Miller-Modigliani Valuation Formula: Revisiting the Fama-French Analysis (June 19, 2012). Available at SSRN: https://ssrn.com/abstract=1800603 or http://dx.doi.org/10.2139/ssrn.1800603

Gil Aharoni (Contact Author)

University of Melbourne ( email )

185 Pelham Street
Carlton, Victoria 3053
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Bruce D. Grundy

University of Melbourne ( email )

Faculty of Economics & Commerce
Department of Finance
Victoria, 3010
Australia
+61 3 8344 9083 (Phone)
+61 3 8344 6914 (Fax)

Qi Zeng

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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