The Great Divorce Between Investment and Profitability
with Mete Kilic and Ben Zhang
We document novel facts about the U.S. stock market during the past forty years which show opposing characteristics to the prior decades: A negative cross-sectional correlation between firms' investment and profitability, and strong premia of investment and profitability factors which are positively correlated. A model of firms with heterogeneous cash flow duration explains these findings: Firms with higher duration have lower discount rates, leading them to invest more despite having lower current profitability. An influx of high-duration firms boosted investment and profitability premia due to the duration premium. These nuances do not exist in countries where long-term investments are scarce.
Presentations: SFS Cavalcade 2020, MFA 2020, AFA 2021 (scheduled)
Predicting Stock Market Returns with an Accounting Factor (** available upon request **)
A predictive factor constructed from aggregate accounting variables robustly predicts month-ahead stock market returns. The factor obtains out-of-sample R-squared statistics of up to 3.05% and the predictive performance is economically large with mean-variance investors being willing to pay an annual fee of up to 6.81% for access to its forecasts. Furthermore, its predictive ability is higher for short-term returns and it is distinct from other predictors in the forecasting literature. Using Google search volume of stock tickers, we demonstrate that the predictive power stems from slow information diffusion due to investor inattention.