Profit Persistence and Stock Returns: Does the Market Care?

Abstract

We examine the relation between stock returns and profit persistence. Profit persistence is an indicator of competitive pressure or managerial ability. This, in turn, can impact firm risk and cash flow and thus stock returns. Using data on US firms, we consider panel regression at both sector and market levels. Using proxy variables for cash flow, risk and managerial ability and three different measures of profit, we establish that persistence typically increases in firm size, market concentration, cash flow, managerial ability and output growth, and decreases with risk. A positive relation between stock returns and lagged persistence supports the view that higher prices arise from higher cash flow, lower risk and greater managerial ability. These results have implications for asset price modelling, with our firm-level results differing from market-level results regarding the cash flow and risk premium drivers. Also, for competition policy where results show higher profit persistence is associated with good management and lower risk.