The Explanatory Power of Alternative Income Measures on Stock Prices: Evidence for Canadian Real Estate Investment Trusts

Abstract

The relationship between performance measures and stock prices is well documented in the financial literature. Some studies find that the relationship is positive (Lev, 1989) and others find a negative relationship (Anwaar, 2016, Sloan, 1996), although most studies exclude REITs due to their unique tax exemptions. This paper examines the explanatory power of net income (NT) and funds from operations (FFO) as it relates to stock return in Canadian real estate investment trusts (REITs) that traded on the Toronto Stock Exchange (TSE) during the 2001-2016 period. Legislation exempts Canadian REITs from corporate taxes as long as they satisfy a number of mandated requirements. The most essential legal requirement is the payment of dividend as a specified percentage of a REITs cash flow. Industry-specific cash flow measures, such as NI, FFO, or cash flow distributions may explain their stock are return performance in Canada. In particular, FFO my explain stock return performance better than NI or distribution due to its unique qualities. Analysis on a hand-collected and proprietary Canadian REIT quarterly data set that covers 2001 to 2016 reveals that FFO does in fact have better explanatory power than NI, consistent with studies of U.S. REITs.