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On the determinants of stock returns

On the determinants of stock returns. Objective. Present recent empirical evidence on the determinants of stock returns. Outline. A review of determinants of stock returns Empirical evidence. Common sense determinants of stock returns. Risk factors Liquidity factors Measures of cheapness

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On the determinants of stock returns

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  1. On the determinants of stock returns

  2. Objective Present recent empirical evidence on the determinants of stock returns

  3. Outline • A review of determinants of stock returns • Empirical evidence

  4. Common sense determinants of stock returns • Risk factors • Liquidity factors • Measures of cheapness • Measures of profitability • Technical factors • Sector-related factors

  5. Risk factors • Market beta (trailing 60-montth) • APT betas • Volatility of total return (trailing 60-month) • Residual variance (firm-specific risk over trailing 60-month) • Debt-to-equity ratio • NOI/Interest charges

  6. Liquidity factors • Market capitalization • Market price per share • Trading volume-to-market capitalization (trailing 12-month)

  7. Measures of cheapness • P/E ratios • Market-to-book ratio • Dividend yield • OCF-to-price • Sales-to-price

  8. Measures of profitability • Profit margin • Total sales/total assets • ROA • ROE • Earnings growth (trailing 5-year) • Earnings surprise

  9. Technical factors • Excess return (relative to the S&P 500) in the previous 1 month • Excess return (relative to the S&P 500) in the previous 2 months • Excess return (relative to the S&P 500) in the previous 6 months • Excess return (relative to the S&P 500) in the previous 12 months • Excess return (relative to the S&P 500) in the previous 24 months • Excess return (relative to the S&P 500) in the previous 60 months

  10. Sector-related factors • Durable goods • Utilities • Energy • Constructions • Manufacturing • etc

  11. Reality check: Empirical evidence Use stocks from the Russell 3000 Stock Index from 1979 to 1993 Run regression: R = a +b1Det1 + b2Det2 + ……+ e

  12. Top ten stock return determinants in the decreasing order of statistical significance: • Excess return (relative to the S&P 500) in the previous 1 month (-) • Excess return (relative to the S&P 500) in the previous 12 months (+) • Trading volume-to-market capitalization (trailing 12-month) (-) • Excess return (relative to the S&P 500) in the previous 2 months (-) • P/E ratios (-) • ROE (+) • Market-to-book ratio (-) • Excess return (relative to the S&P 500) in the previous 6 months (+) • Trading volume trend (-) • OCF-to-price (+)

  13. Interpretation • Short-term reversal • Medium-term momentum • Long-term reversal • Investors overestimate the mean-reversion period and/or growth rates (cheap stocks earn higher returns) • Liquid stocks have lower expected returns

  14. More questions What is the relationship between risk and return? Why do cheaper stocks have higher returns?

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