49 Pages Posted: 4 Nov 2021 Last revised: 1 Jun 2022
Date Written: October 27, 2021
Using realized earnings over long periods of time, we investigate errors in earnings expectations implied by stock prices of firms. We compute realized lifetime earnings for each firm starting at the IPO date and the beginning of each subsequent year and compare it to stock price on that date. Of the 16,386 firms examined, only 17% survived till 2019, 42% merged with other firms and the rest were delisted for other reasons. While the average lifetime earnings at the aggregate level slightly exceeds first day price, the results are driven by roughly 33% of the firms in the sample. Mergers account for most of success in recovering the first day stock price and appear to be the best way to generate enough earnings to justify valuations. Even among firms that survived, over 46% have yet to generate enough earnings to justify their first day valuations even though they have been in business between 15 and 45 years. Aggregate free cash flows over the lifetime of all firms are lower than the lifetime earnings and justify 80% of the first day trading price. We relate our paper to Bessembinder (2018) by examining the link between lifetime earnings (as a measure of fundamental wealth creation) and stock returns-based wealth creation. We find that lifetime earnings are positively associated with future returns-based wealth creation while current returns-based wealth created itself is negatively associated with future returns-based wealth creation. These results point to a disconnect between returns-based wealth creation and fundamental wealth creation in the short to medium term that eventually corrects.
Keywords: lifetime, earnings, stock returns, wealth creation, mergers, IPOs
JEL Classification: G11, G12, G23, G32, M41
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