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Do Investors Overvalue Firms with Bloated Balance Sheets?

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  • Hirshleifer, David

    (Ohio State U)

  • Hou, Kewei
  • Teoh, Siew Hong
  • Zhang, Yinglei

Abstract

When cumulative net operating income (accounting value-added) outstrips cumulative free cash flow (cash value-added), subsequent earnings growth is weak. If investors with limited attention focus on accounting profitability, and neglect information about cash profitability, then net operating assets, the cumulation of the discrepancies between the two, measures the extent to which reporting outcomes provoke over-optimism. During the 1964-2002 sample period, net operating assets scaled by total assets is a strong negative predictor of long-run stock returns. Predictability is robust with respect to an extensive set of controls and testing methods.

Suggested Citation

  • Hirshleifer, David & Hou, Kewei & Teoh, Siew Hong & Zhang, Yinglei, 2004. "Do Investors Overvalue Firms with Bloated Balance Sheets?," Working Paper Series 2004-18, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2004-18
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