Abstract
Purpose This study aims to analyze the influence of future expectations of the book-to-market ratio (B/M) and return on equity (ROE) in explaining the Brazilian capital market returns. Design/methodology/approach The study analyzed the explanatory power of risk-factor approach variables such as beta, size, B/M ratio, momentum and liquidity. Findings The results show that future expectations of the B/M ratio and ROE, when combined with proxies for risk factors, were able to explain part of the variations of Brazilian stock returns. With respect to risk factors approach variables, the authors verified the existence of size and B/M effects and a liquidity premium in the Brazilian capital market, during the period analyzed. Research limitations/implications This research was limited to the non-financial companies with shares traded at Brasil, Bolsa and Balcão, from January 1, 1995 to June 30, 2015. This way, the conclusions reached are limited to the sample used herein. Practical implications The evidences herein presented can also contribute to establishing investment strategies, considering that the B/M ratio may be calculated through accounting information announced by companies. Besides, using historical data enable investors, in a specific year, to calculate the predictor variables for the B/M ratio and ROE in the next year, which enhance the explanatory power of the current B/M, when combined in the form of an aggregate predictor variable for stock returns. Originality/value The main contribution of this study to the literature is to demonstrate how the expected future B/M ratio and ROE may improve the explanatory capacity of the stock return, when compared with the variables traditionally studied in the literature.
Highlights
The efficient market hypothesis and the asset pricing models constitute one of the main pillars of the modern finance theory
The results found in this study show that the book-to-market ratio (B/M) has an explanatory capacity when combined with the expected future B/M and return on equity (ROE), as an aggregate predictor variable and as a risk factor
This paper aimed to study the influence of expected future B/M ratio and ROE on explaining Brazilian stock market returns
Summary
The efficient market hypothesis and the asset pricing models constitute one of the main pillars of the modern finance theory. Fundamental valuation considers the B/M ratio to be a more consistent variable than firm size to explain stock returns According to this perspective, the relation between the B/M and the future returns is not given by the fact that B/M captures a risk factor but, rather, because it is a proxy for the expected cash flows, which correspond to an omitted term in the relation between market value and the expected returns. This identity originated the fundamental analysis model to be analyzed in this study The logics underlying this argument is that inclusion of expected future ROE (in addition to current B/M) as an explanatory variable for stock returns, controls for cross-firm variation in current B/M caused by differences in expectations of short-term fundamental economic performance.
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