Download this Paper Open PDF in Browser

Earnings, Retained Earnings, and Book-to-Market in the Cross Section of Expected Returns

54 Pages Posted: 1 Mar 2017 Last revised: 25 Sep 2017

Ray Ball

University of Chicago - Booth School of Business

Joseph J. Gerakos

Tuck School of Business at Dartmouth College

Juhani T. Linnainmaa

USC Marshall School of Business; National Bureau of Economic Research (NBER)

Valeri V. Nikolaev

University of Chicago Booth School of Business

Date Written: September 25, 2017

Abstract

We delve into what causes the relation between book-to-market and the cross section of stock returns. Book value of equity consists of two main components that we expect contain different information about expected returns: retained earnings and contributed capital. Retained earnings-to-market subsumes book-to-market's power to predict the cross section of stock returns in pre- and post-Compustat U.S. data as well as in international data. Contributed capital-to-market has no predictive power. Retained earnings represent the accumulated difference between earnings and dividends. We show that retained earnings-to-market's predictive power stems entirely from accumulated earnings. Our thesis is that retained earnings-to-market---and, by extension, book-to-market---predicts returns because it is a good proxy for earnings yield (Ball,1978; Berk, 1995).

Keywords: G11, G12, M41

JEL Classification: Book-to-market, Contributed capital, Earnings yield, Mispricing, Retained earnings, Value premium

Suggested Citation

Ball, Ray and Gerakos, Joseph J. and Linnainmaa, Juhani T. and Nikolaev , Valeri V., Earnings, Retained Earnings, and Book-to-Market in the Cross Section of Expected Returns (September 25, 2017). Chicago Booth Research Paper No. 17-03. Available at SSRN: https://ssrn.com/abstract=2924798 or http://dx.doi.org/10.2139/ssrn.2924798

Ray Ball

University of Chicago - Booth School of Business ( email )

Joseph Gerakos

Tuck School of Business at Dartmouth College ( email )

Hanover, NH 03755
United States

Juhani Linnainmaa

USC Marshall School of Business ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Valeri Nikolaev (Contact Author)

University of Chicago Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/valeri.nikolaev/index.html

Paper statistics

Downloads
915
Rank
20,337
Abstract Views
2,010