Faculty of Business Administration, Simon Fraser University
Abstract:
We develop an expected return measure from a dynamic equity valuation model. We show that expected return from Blazenko and Pavlov’s (2009) dynamic equity valuation model has two terms: one that is easy to calculate with readily available financial market measures and does not require statistical estimation and a component that depends on earnings volatility. We entitle the first portion as static growth expected return (SGER). We use analysts’ earnings forecasts as an SGER input to rank firms for portfolio inclusion. We find that SGER discriminates stocks with significant excess returns?non-zero alphas?in two conditional asset pricing models. The estimated alpha difference between high and low SGER portfolios is as great as 0.91% per month. Consistent with the dynamic model, returns increase with profitability to a greater extent for value compared to growth firms. Analysts make favorable stock recommendations and most optimistically forecast earnings for high SGER firms. We find little statistical or economic significance for earnings volatility beyond SGER for returns. This observation is consistent with SGER as a large portion of expected return from the dynamic model. We conclude that SGER on its own is a useful return measure for common share investing.
