Fundamentals versus Beta — What Drives Stock Returns?

Abstract

Ever since people have invested their money into stocks they have been interested in the forces which drive stock returns. First, an analysis of these forces helps the investor to understand why stock returns have developed in a certain way during the past. Second, it might help him to make better investment decisions during the future. The main question of this chapter is which are the variables which explain the cross section of stock returns. I relate the cross section of stock returns to two sets of explanatory variables, the CAPM β and size on the one hand and to fundamentals on the other hand. I have already used these variables to explain stock returns in previous chapters. Starting point there has been the observed time series pattern. The main part of the analysis has concentrated on the explanation of long-term reversals in the cross section of excess returns. The CAPM showed only limited explanatory power whereas the pattern in fundamental variables was in line with the pattern of excess returns. This evidence suggests that fundamentals explain the cross section of stock returns better than the CAPM β. In this chapter, I test for differences in the explanatory power directly.KeywordsExplanatory PowerStock ReturnPost RegressionExcess ReturnInvestment HorizonThese keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.