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The Usefulness of Book‐to‐Market and ROE Expectations for Explaining UK Stock Returns
Author(s) -
Clubb Colin,
Naffi Mounir
Publication year - 2007
Publication title -
journal of business finance and accounting
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.282
H-Index - 77
eISSN - 1468-5957
pISSN - 0306-686X
DOI - 10.1111/j.1468-5957.2006.00662.x
Subject(s) - stock (firearms) , economics , financial economics , valuation (finance) , econometrics , equity (law) , growth stock , cash flow , stock market , proxy (statistics) , stock market bubble , finance , mathematics , mechanical engineering , paleontology , horse , political science , law , biology , engineering , statistics
The fundamental valuation perspective on stock returns suggests that book‐to‐market will be positively related to returns if market value of equity equals future expected cash flows discounted at the expected return and book value proxies for future cash flows. Building on this perspective, we develop a log linear model which includes expectations of future BM and ROE in addition to current BM as explanatory variables for future stock returns. We show that these three variables explain a significant part of UK cross‐sectional stock returns and that they remain highly statistically significant after including additional risk proxy variables. This supports relevance of fundamental valuation based firm characteristics for explaining stock returns and indicates their potential usefulness for predicting future stock returns.