Sexy or Safe: Why Do Predicted Stock Issuers (PSIs) Earn Low Returns?

Charles Lee and Ken Li
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Ken Li: Stanford University

Research Papers from Stanford University, Graduate School of Business

Abstract: Predicted stock issuers (PSIs) are firms with expected "high-investment and low-profit" (HILP) profiles that earn unusually low returns. Over a 36-year period (1978-2013), average returns to top-decile PSIs are indistinguishable from Treasury yields. We show these firms have lottery-like payoffs, high volatility, high Beta, and high shorting costs. They are cash-strapped and most will need additional financing. Top-PSIs generate future average return-on-assets of -30% per year, report disappointing earnings, and experience strongly-negative analyst forecast revisions. They earn especially low returns in down markets and are nine times more likely to delist for performance reasons than low-PSI firms. We conclude that top-PSIs, and HILP firms in general, earn low returns because they are more salient (i.e., sexier) to investors and thus overpriced, not because they are safer.

Date: 2017-02
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