This paper examines the time-series relations among expected return, risk, and book-to-market (B/M) at the portfolio level. I find that B/M predicts economically and statistically significant time-variation in expected stock returns. Further, B/M is strongly associated with changes in risk, as measured by the Fama and French (1993) (Journal of Financial Economics, 33, 3–56) three-factor model. After controlling for risk, B/M provides no incremental information about expected returns. The evidence suggests that the three-factor model explains time-varying expected returns better than a characteristics-based model.

We study the investment–cash flow sensitivities of U.S. firms from 1971–2009. Our tests extend the literature in several key ways and provide strong evidence that cash flow explains investment beyond its correlation with q . A dollar of current- and prior-year cash flow is associated with $0.32 of additional investment for firms that are the least likely to be constrained and $0.63 of additional investment for firms that are the most likely to be constrained, even after correcting for measurement error in q . Our results suggest that financing constraints and free-cash-flow problems are important for investment decisions.