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The Value of Growth: Changes in Profitability and Future Stock Returns

56 Pages Posted: 10 Aug 2016 Last revised: 2 Sep 2017

Juan M. Sotes-Paladino

University of Melbourne - Department of Finance

George Jiaguo Wang

Manchester Business School; New York University - Stern School of Business

Yaqiong (Chelsea) Yao

Lancaster University - Management School; New York University (NYU) - Leonard N. Stern School of Business

Date Written: August 30, 2017

Abstract

The dividend-discount model predicts a positive relation between expected changes in a firm’s profitability, or profitability growth, and stock returns. We find this prediction to be borne out in the data. Across U.S. stocks, firms with strong past profitability growth outperform firms with weak past profitability growth. A long-short strategy based on profitability growth yields significant risk-adjusted returns, both in the overall sample and across firm-size levels. The predictive power of profitability growth is economically strong and statistically significant when compared with well-documented, cross-sectional determinants such as profitability levels, earnings momentum, profit trend, size, book-to-market, or price momentum.

Keywords: Profitability; Growth; Return Predictability; Stock Returns

JEL Classification: G11; G12

Suggested Citation

Sotes-Paladino, Juan M. and Wang, George Jiaguo and Yao, Yaqiong (Chelsea), The Value of Growth: Changes in Profitability and Future Stock Returns (August 30, 2017). 29th Australasian Finance and Banking Conference 2016. Available at SSRN: https://ssrn.com/abstract=2819183

Juan Sotes-Paladino

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Parkville, Victoria 3010 3010
Australia
+61 3 9035 9827 (Phone)
+61 3834 6914 (Fax)

George Wang

Manchester Business School

Crawford House
Oxford Road
Manchester, M15 6PB
United Kingdom
+447516389968 (Phone)

HOME PAGE: http://www.mbs.ac.uk/research/people/profiles/gwang

New York University - Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

Yaqiong (Chelsea) Yao (Contact Author)

Lancaster University - Management School ( email )

Department of Accounting and Finance
Lancaster University Management School
Lancaster, LA1 4YX
United Kingdom
+44 (0)1524 510731 (Phone)

New York University (NYU) - Leonard N. Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY NY 10012
United States

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