Expected Earnings Growth, Stock Valuation and Investor Sentiment
57 Pages Posted: 16 Sep 2011 Last revised: 20 May 2012
Date Written: May 1, 2012
The sensitivity of stock valuations to expected earnings growth, termed as the growth premium, fluctuates substantially over time. This study empirically investigates whether these fluctuations can be explained by investor sentiment. The testable prediction is that investor sentiment affects the growth premium, causing expected earnings growth to be valued differently. The results show that expected earnings growth is valued high (low) in periods in which measures of investor sentiment are high (low). The effect of sentiment on the growth premium is documented both in the cross section of individual stocks and at the aggregate market level. Moreover, future return patterns based on growth-related characteristics are consistent with the hypothesis that sentiment causes the mispricing of stocks whose earnings are expected to grow quickly, and of stocks whose growth is valued at extreme levels. The impact of sentiment on the growth premium is robust after controlling for recognized proxies for risk premia.
Keywords: stock valuation, earnings growth, mispricing, investor sentiment
JEL Classification: G12, M41
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