The Wealth Creation Effect in Stock Returns
68 Pages Posted: 17 Mar 2022 Last revised: 15 May 2023
Date Written: March 15, 2022
In corporate finance, investment is viewed as a value-creating activity when it generates payoffs above the cost of capital. Incorporating this insight into asset pricing tests, the paper challenges the traditional view on the sign of the correlation between investment and stock returns. Starting from a discounted cash-flow tautology, we argue that expected returns correlate positively with investment whenever the return on equity exceeds the cost of capital. The empirical evidence supports this channel. The interaction of profitability and investment positively correlates with stock returns, and a factor building on this interaction earns a premium of about 24bps per month.
Keywords: Investment Anomaly, Profitability Anomaly, Investment Factor, Profitability Factor, Asset Pricing, Net-Present Value, Wealth Creation
JEL Classification: G11, G12
Suggested Citation: Suggested Citation