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Stock Valuation and Learning about Profitability

Author

Listed:
  • Lubos PÁstor

    (Graduate School of Business, University of Chicago.)

  • Veronesi Pietro

    (Graduate School of Business, University of Chicago.)

Abstract

We develop a simple approach to valuing stocks in the presence of learning about average profitability. The market-to-book ratio (M/B) increases with uncertainty about average profitability, especially for firms that pay no dividends. M/B is predicted to decline over a firm's lifetime due to learning, with steeper decline when the firm is young. These predictions are confirmed empirically. Data also support the predictions that younger stocks and stocks that pay no dividends have more volatile returns. Firm profitability has become more volatile recently, helping explain the puzzling increase in average idiosyncratic return volatility observed over the past few decades. Copyright (c) 2003 by the American Finance Association.

Suggested Citation

  • Lubos PÁstor & Veronesi Pietro, 2003. "Stock Valuation and Learning about Profitability," Journal of Finance, American Finance Association, vol. 58(5), pages 1749-1790, October.
  • Handle: RePEc:bla:jfinan:v:58:y:2003:i:5:p:1749-1790
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    References listed on IDEAS

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    1. Randolph B. Cohen & Christopher Polk & Tuomo Vuolteenaho, 2003. "The Value Spread," Journal of Finance, American Finance Association, vol. 58(2), pages 609-642, April.
    2. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    3. Jonathan Lewellen & Jay Shanken, 2002. "Learning, Asset-Pricing Tests, and Market Efficiency," Journal of Finance, American Finance Association, vol. 57(3), pages 1113-1145, June.
    4. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
    5. Jovanovic, Boyan, 1982. "Selection and the Evolution of Industry," Econometrica, Econometric Society, vol. 50(3), pages 649-670, May.
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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