Scale or Yield? A Present-Value Identity

Publication Date
Financial Markets Group Discussion Papers DP 905
Publication Authors

We propose a loglinear present-value identity in which investment ("scale"), profitability ("yield"), and discount rates determine a firm’s market-to-book ratio. Our identity reconciles existing influential market-to-book decompositions and facilitates novel insights from three empirical applications: (i) Both investment and profitability are important contributors to the value spread and stock return news variance. (ii) Any cross-sectional return predictability has a mirror image in cash-flow fundamentals, providing asset-pricing theories with additional moments to match. (iii) The investment spread significantly improves the predictability of time-series variation in the value premium and justifies the poor performance of value in recent years.