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

55 Pages Posted: 10 Aug 2016 Last revised: 4 Mar 2021

See all articles by Bryan Lim

Bryan Lim

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

Juan M. Sotes-Paladino

Universidad de los Andes, Chile

George Jiaguo Wang

Lancaster University Management School; New York University - Stern School of Business

Chelsea Yaqiong Yao

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

Date Written: January 21, 2021

Abstract

We use a simple two-stage growth model to connect profitability growth to returns. In this framework, both the magnitude and the length of the first-stage growth play a key role in determining returns. Using current profitability growth to estimate magnitude and firm size to estimate the inverse of length, we predict that future returns should be increasing in current profitability growth, but the effect should diminish with firm size. Across a range of empirical tests, we find strong evidence in support for our hypotheses. The predictive effects are not subsumed after controlling for an array of associated, potentially confounding variables.

Keywords: Profitability Growth; Firm Size; Stock Returns

JEL Classification: G11; G12

Suggested Citation

Lim, Bryan and Sotes-Paladino, Juan M. and Wang, George Jiaguo and Yao, Yaqiong, The Value of Growth: Changes in Profitability and Future Stock Returns (January 21, 2021). 29th Australasian Finance and Banking Conference 2016, Asian Finance Association (AsianFA) 2018 Conference, Available at SSRN: https://ssrn.com/abstract=2819183 or http://dx.doi.org/10.2139/ssrn.2819183

Bryan Lim

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

Juan M. Sotes-Paladino

Universidad de los Andes, Chile ( email )

Chile

George Jiaguo Wang

Lancaster University Management School ( email )

Department of Accounting and Finance
Lancaster University Management School
Lancaster, Lancashire LA1 4YX
United Kingdom
+44 1524 592 577 (Phone)

HOME PAGE: http://www.lancaster.ac.uk/lums/people/george-wang

New York University - Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

Yaqiong Yao (Contact Author)

Lancaster University - Management School ( email )

Department of Accounting and Finance
Lancaster University Management School
Lancaster, LA1 4YX
United Kingdom

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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