Does Earnings Growth Drive the Quality Premium?
38 Pages Posted: 13 Jun 2016 Last revised: 13 Jun 2018
Date Written: May 16, 2018
High (low) quality stocks generate anomalously high (low) returns from the stand point of prominent asset pricing models. We provide a comprehensive overview of the commonly used quality definitions, and test their predictive power for stock returns. We show that quality measures predict stock returns if and only if they forecast earnings growth, and that this information is not contained in other characteristics that have been shown to drive expected returns on stocks. Our results provide empirical evidence supporting the theoretical relation between profitability, investments, and expected stock returns, proposed by Fama and French (2015), across various markets, and thereby help better understand the existence of the quality anomaly.
Keywords: quality, factor premiums, earnings growth, return-on-equity, profit margins, leverage, earnings variability, operating accruals, investments, gross profitability
JEL Classification: C12, G11, G12, G14
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