2. On the determinants of stock returns

3. Objective Present recent empirical evidence on the determinants of stock returns

4. Outline A review of determinants of stock returns Empirical evidence

5. Common sense determinants of stock returns Risk factors Liquidity factors Measures of cheapness Measures of profitability Technical factors Sector-related factors

6. Risk factors Market beta (trailing 60-montth)  APT betas  Volatility of total return (trailing 60-month)  Residual variance (firm-specific risk over trailing 60-month)  Debt-to-equity ratio  NOI/Interest charges

7. Liquidity factors Market capitalization  Market price per share  Trading volume-to-market capitalization (trailing 12-month)

8. Measures of cheapness P/E ratios  Market-to-book ratio  Dividend yield  OCF-to-price  Sales-to-price

9. Measures of profitability Profit margin Total sales/total assets ROA ROE Earnings growth (trailing 5-year)  Earnings surprise

10. Technical factors Excess return (relative to the S&P 500) in the previous 1 month  Excess return (relative to the S&P 500) in the previous 2 months  Excess return (relative to the S&P 500) in the previous 6 months  Excess return (relative to the S&P 500) in the previous 12 months  Excess return (relative to the S&P 500) in the previous 24 months Excess return (relative to the S&P 500) in the previous 60 months

11. Sector-related factors Durable goods  Utilities  Energy  Constructions  Manufacturing  etc

12. Reality check: Empirical evidence Use stocks from the Russell 3000 Stock Index from 1979 to 1993 Run regression: R = a +b 1 Det 1 + b 2 Det 2 + ……+ e

13. Top ten stock return determinants in the decreasing order of statistical significance: Excess return (relative to the S&P 500) in the previous 1 month (-) Excess return (relative to the S&P 500) in the previous 12 months (+) Trading volume-to-market capitalization (trailing 12-month) (-) Excess return (relative to the S&P 500) in the previous 2 months (-) P/E ratios (-) ROE (+) Market-to-book ratio (-) Excess return (relative to the S&P 500) in the previous 6 months (+) Trading volume trend (-) OCF-to-price (+)

14. Interpretation Short-term reversal Medium-term momentum Long-term reversal Investors overestimate the mean-reversion period and/or growth rates (cheap stocks earn higher returns) Liquid stocks have lower expected returns

15. More questions What is the relationship between risk and return? Why do cheaper stocks have higher returns?