Levels of Total Book Assets and Future Stock Returns: Risk or Mispricing?

Abstract

This study investigates whether increases in future stock returns related to levels of total book assets (TBA), after controlling for market value (MV), are due to risk or stock mispricing. Based on a 30 year sample from 1987 to 2016, the findings reveal statistically significant average annual abnormal returns in the range of 5.5 and 10 percent using the Carhart (1997) four-factor model when going from the lowest to the highest TBA quintile portfolio, after sorting stocks into market value quintiles. Abnormal portfolio returns are even higher in the latter seven years of the sample period. These abnormal portfolio returns are supported by firm-level pooled regressions that include a battery of control variables known to be related to future stock returns. Moreover, these abnormal returns are not related to the accruals or asset growth anomalies. However, the evidence lends support to the behavioral explanation of investors not fully incorporating current investments and prior poor performance of firms into stock prices. Taken together, these findings suggest potentially significant abnormal returns for investors and provide support for standard setters who want more fair values in accounting assets.

Keywords: total book assets, abnormal returns, accounting standards, investment growth

JEL Classification: G12, G17, M410