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Profits and stock prices: the importance of being earnest

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  • Richard W. Kopcke
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    Abstract

    While the prospect for equity values naturally concerns traders and investors, it also is a concern for public policy. Because investors’ wealth depends on the value of corporate equity, the demand for consumption goods can vary with the price of stocks. The valuation of corporations’ productive assets on stock exchanges also influences businesses’ willingness and ability to undertake new investments. If the falling price of stocks should retard the pace of capital formation in the future, it also would retard the potential growth of output and living standards. ; This article examines the relationship between the earnings of non financial corporations and the value of their equity. It concludes that the price of stocks corresponds more closely to the earnings that companies disclose in their financial reports than it does to the earnings for nonfinancial corporations reported in the national income accounts. This analysis also suggests that the value of equity does not necessarily reflect corporations’ incentives for undertaking investments. If the opportunities for profitable growth, both here and abroad, remain sufficiently attractive, lower prices of stocks would not foretell a commensurate drop in corporations’ capital budgets.

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    File URL: http://www.bostonfed.org/economic/neer/neer1992/neer292c.pdf
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    Bibliographic Info

    Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

    Volume (Year): (1992)
    Issue (Month): Mar ()
    Pages: 26-44

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    Handle: RePEc:fip:fedbne:y:1992:i:mar:p:26-44

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    Related research

    Keywords: Stock - Prices;

    References

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    1. Robert J. Shiller & John Y. Campbell, 1986. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Cowles Foundation Discussion Papers 812, Cowles Foundation for Research in Economics, Yale University.
    2. Pindyck, Robert, 1989. "Irreversibility, uncertainty, and investment," Policy Research Working Paper Series 294, The World Bank.
    3. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, vol. 49(3), pages 555-74, May.
    4. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
    5. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411.
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    9. Hsieh, David A, 1991. " Chaos and Nonlinear Dynamics: Application to Financial Markets," Journal of Finance, American Finance Association, vol. 46(5), pages 1839-77, December.
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    12. Sudipto Bhattacharya, 1979. "Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 259-270, Spring.
    13. Yoshikawa, Hiroshi, 1980. "On the "q" Theory of Investment," American Economic Review, American Economic Association, vol. 70(4), pages 739-43, September.
    14. George M. Von Furstenberg, 1977. "Corporate Investment: Does Market Valuation Matter in the Aggregate?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 8(2), pages 347-408.
    15. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    16. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
    17. Stephen K. McNees, 1991. "How fast can we grow?," New England Economic Review, Federal Reserve Bank of Boston, issue Jan, pages 3-14.
    18. DeJong, David N & Whiteman, Charles H, 1991. "The Temporal Stability of Dividends and Stock Prices: Evidence from the Likelihood Function," American Economic Review, American Economic Association, vol. 81(3), pages 600-617, June.
    19. Miller, Merton H. & Scholes, Myron S., 1978. "Dividends and taxes," Journal of Financial Economics, Elsevier, vol. 6(4), pages 333-364, December.
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