The Wealth Creation Effect in Stock Returns

56 Pages Posted: 17 Mar 2022 Last revised: 9 May 2022

See all articles by Francesco A. Franzoni

Francesco A. Franzoni

Universita della Svizzera italiana (USI Lugano); Swiss Finance Institute; Centre for Economic Policy Research (CEPR)

Daniel Obrycki

The Applied Finance Group, Ltd.

Rafael Resendes

The Applied Finance Group, Ltd.

Multiple version iconThere are 2 versions of this paper

Date Written: March 15, 2022

Abstract

In the asset pricing literature, higher investment is associated with lower expected stock returns. On the other hand, practitioners view investment as a value-creating activity when it generates payoffs above the cost of capital. The paper reconciles these views. Starting from a discounted cash-flow tautology, we argue that expected returns correlate positively with expected investment whenever the return on equity is large enough. We label this prediction the wealth creation effect. The empirical evidence supports this channel. The interaction of profitability and investment positively correlates with stock returns controlling for the usual characteristics. A wealth creation factor earns a premium of about 24bps per month leading to sizeable Sharpe ratio improvements relative to popular factor models.

Suggested Citation

Franzoni, Francesco A. and Obrycki, Daniel and Resendes, Rafael, The Wealth Creation Effect in Stock Returns (March 15, 2022). Swiss Finance Institute Research Paper No. 22-27, Available at SSRN: https://ssrn.com/abstract=4058538 or http://dx.doi.org/10.2139/ssrn.4058538

Francesco A. Franzoni (Contact Author)

Universita della Svizzera italiana (USI Lugano) ( email )

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Daniel Obrycki

The Applied Finance Group, Ltd. ( email )

65 E. Wacker Place
Suite 1600
CHICAGO, IL 60601
United States
312-362-9903 (Phone)
312-362-0222 (Fax)

HOME PAGE: http://www.appliedfinance.com

Rafael Resendes

The Applied Finance Group, Ltd. ( email )

65 E. Wacker Place
Suite 1600
CHICAGO, IL 60601
United States
312-362-9903 (Phone)
312-362-0222 (Fax)

HOME PAGE: http://www.appliedfinance.com

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