ABSTRACT We propose a novel way to estimate a portfolio's abnormal price , the percentage gap between price and the present value of dividends computed with a chosen asset pricing model. Our method, based on a novel identity, resembles the time‐series estimator of abnormal returns, avoids the issues in alternative approaches, and clarifies the role of risk and mispricing in long‐horizon returns. We apply our techniques to study the cross‐section of price levels relative to the capital asset pricing model (CAPM) and find that a single characteristic, adjusted value , provides a parsimonious model of CAPM‐implied abnormal price.

We propose a loglinear present-value identity in which investment (“scale”), profitability (“yield”), and discount rates determine a firm’s market-to-book ratio. Our identity reconciles existing influential market-to-book decompositions and facilitates novel insights from three empirical applications: (1) Both investment and profitability are important contributors to the value spread and stock return news variance. (2) Any cross-sectional return predictability has a mirror image in cash-flow fundamentals, providing asset pricing theories with additional moments to match. (3) The investment spread significantly improves the predictability of time-series variation in the value premium and justifies the poor performance of value in recent years.