Earnings, retained earnings, and book-to-market in the cross section of expected returns

Ray Ball (), Joseph Gerakos, Juhani T. Linnainmaa and Valeri Nikolaev

Journal of Financial Economics, 2020, vol. 135, issue 1, 231-254

Abstract: Book value of equity consists of two economically different components: retained earnings and contributed capital. We predict that book-to-market strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. Retained earnings-to-market predicts the cross section of average returns in U.S. and international data and subsumes book-to-market. Contributed capital-to-market has no predictive power. We show that retained earnings-to-market, and, by extension, book-to-market, predicts returns because it is a good proxy for underlying earnings yield (Ball, 1978; Berk, 1995) and not because book value represents intrinsic value.

Keywords: Book-to-market; Contributed capital; Earnings yield; Mispricing; Retained earnings; Value premium (search for similar items in EconPapers)
JEL-codes: G11 G12 M41 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:135:y:2020:i:1:p:231-254

DOI: 10.1016/j.jfineco.2019.05.013

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