Expected Investment Growth as Stock Return Predictor
January 6, 2017 - Fundamental Valuation
Do stocks with expectations of high capital expenditures (growth opportunities) outperform those with expectations of low capital expenditures? In their December 2016 paper entitled “Expected Investment Growth and the Cross Section of Stock Returns”, Jun Li and Huijun Wang examine the power of expected investment growth (EIG) to predict cross-sectional stock returns. They construct EIG for each stock monthly in two steps:
- Regress actual investment (capital expenditures) growth jointly versus prior-month momentum (stock return from 12 months ago to two months ago), q (firm market value divided by capital) and cash flow.
- Apply the resulting regression betas to latest momentum, q and cash flow values to project next-month EIG.
They measure the EIG factor premium as gross average return to a portfolio that is each month long (short) the value-weighted tenth, or decile, of stocks with the highest (lowest) EIGs. They consider an array of tests to measure the strength and robustness of this factor premium. Using monthly data for a broad sample of U.S. stocks (excluding financial and utility stocks) during July 1953 through December 2015, they find that: Keep Reading