Future Realized Return, Firm-Specific Risk and the Implied Expected Return

Abstract

In this paper, we propose a novel approach to derive a firm-specific measure of expected return. It builds on recent accounting-based valuation models developed by Clubb (2013) and Ashton and Wang (2013). The measure is intrinsically linked to commonly used financial ratios including book-to-market, (forward) earnings yield, dividend-to-price as well as growth and past returns. The empirical evidence shows that it is significantly positively associated with future realized stock returns and also significantly correlates with commonly used risk characteristics in a theoretically predictable manner. The results are likely to be of interest to practitioners and managers in making capital allocation decisions and to academics in need of proxies for firms’ discount rates and expected returns.