Predictability of UK Stock Returns by Using Debt Ratios

Abstract

The purpose of this study is to examine the ability of debt ratios in predicting company performance and stock returns in the long run. The U.K. companies included in the FTSE-350 index for the past ten years constitute our sample. We rank the companies according to the degree of leverage that they have. Then we examine the predictive ability of the debt burden for shareholder wealth by investigating the cumulative abnormal returns and buy and hold returns in the long-run for a holding period of three years. The results show that companies with moderately low leverage yield buy and hold abnormal returns of up to 20% in three years.

Keywords: Capital markets, leverage, forecasting, equity returns