Do Investors Overvalue Firms with Bloated Balance Sheets?

David Hirshleifer, Kewei Hou, Siew Hong Teoh and Yinglei Zhang
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Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: When cumulative net operating income (accounting value-added) outstrips cumulative free cash flow (cash value-added), subsequent earnings growth is weak. If investors with limited attention focus on accounting profitability, and neglect information about cash profitability, then net operating assets, the cumulation of the discrepancies between the two, measures the extent to which reporting outcomes provoke over-optimism. During the 1964-2002 sample period, net operating assets scaled by total assets is a strong negative predictor of long-run stock returns. Predictability is robust with respect to an extensive set of controls and testing methods.

Date: 2004-09
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Related works:
Journal Article: Do investors overvalue firms with bloated balance sheets? (2004)
Working Paper: Do Investors Overvalue Firms With Bloated Balance Sheets? (2004)
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