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Earnings and Expected Returns

  • OWEN LAMONT

The aggregate dividend payout ratio forecasts aggregate excess returns on both stocks and corporate bonds in post-war US data. Both high corporate profits and high stock prices forecast low excess returns on equities. When the payout ratio is high, expected returns are high. The payout ratio's correlation with business conditions gives it predictive power for returns; it contains information about future stock and bond returns that is not captured by other variables. The payout ratio is useful because it captures the temporary components of earnings. The dynamic relationship between dividends, earnings and stock prices shows that a positive innovation in earnings lowers expected returns in the near future, but raises them thereafter.

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Paper provided by Center for Research in Security Prices, Graduate School of Business, University of Chicago in its series CRSP working papers with number 345.

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Handle: RePEc:wop:chispw:345
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