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Stock Valuation and Learning about Profitability

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  • Lubos Pastor
  • Pietro Veronesi

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.

Suggested Citation

  • Lubos Pastor & Pietro Veronesi, 2002. "Stock Valuation and Learning about Profitability," NBER Working Papers 8991, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:8991
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    References listed on IDEAS

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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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