Alternative Profitability Measures and Cross Section of Expected Stock Returns: International Evidence

Abstract

This paper provides an extensive international analysis of the cross-sectional return predictive power of a variety of firm-level profitability measures, calculated from different combinations of measures of earnings and scaling variables. We show that this cross-sectional predictive relation is more pronounced when profit is measured by gross profit and when profits are scaled by enterprise value or market value of equity. Our findings support the hypotheses that the predictive power of “profits-to-market price” factor is partly attributable to stock mispricing arising from systematic behavioral biases and partly to the choice of a “clean” measure of earnings.

Keywords: Profitability, enterprise value, behavioral finance, international asset pricing

JEL Classification: G11, G12, G15