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Journal of Banking & Finance Vol. 158 2024

The value of growth: Changes in profitability and future stock returns

Bryan Lim1; Juan M. Sotes-Paladino2,3; George Jiaguo Wang4; Yaqiong Yao5

1 Associate Professor of Finance, Department of Finance, University of Melbourne, VIC 3010, Australia. Tel: (+61) 383449088 · 2 Department of Finance · 3 In-Q-Tel · 4 Associate Professor of Finance, Department of Accounting and Finance, Lancaster University Management School, Lancaster LA1 4YX, United Kingdom. Tel: (+44) 1524592577 · 5 Associate Professor of Finance, Department of Accounting and Finance, Lancaster University Management School, Lancaster LA1 4YX, United Kingdom. Tel: (+44) 1524510731

open access

Abstract

We use a simple two-stage dividend growth model to connect profitability growth and firm scale to stock returns. In this framework, both the magnitude and the length of the first-stage growth play a key role in determining returns. Using current profitability growth to estimate magnitude and firm scale as inverse proxy for length, we predict that future returns should increase with current profitability growth but, crucially, the effect should diminish with firm scale. Across a range of empirical tests, we find strong evidence in support of our model determinants and predictions. Our findings are not explained by an array of associated, potentially confounding variables.

DOI
10.1016/j.jbankfin.2023.107036
Volume
158
Pages
107036
Language
en
Sources
openalex crossref bibtex:phds-export.bib

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