The impacts of leverage, price book ratio, dividend yield and past performance on stock returns

Abstract

Considering mixed results of several studies that analyse the influence of total leverage on stock returns, we focus on a more differentiated ratio in our approach: ‘total debt to (total capital + long term debt)’ [TD/(TC + LTD)] which treats short- and long-term debt differently. In this article, we employ an investment strategy on the German stock market that is based on TD/(TC + LTD) as well as price to book, dividend yield and past stock performance. Interestingly, the relation between TD/(TC + LTD) and stock returns is negative and highly significant. That is essential because it contradicts one of the basic principles in traditional financial theory. Price book is negatively and dividend yield is positively related to returns. Looking at past performance, we find a significant short-term momentum and long-term contrarian pattern. On balance, those variables impact returns critically. Furthermore, we analyse the question whether differences in returns are a compensation for risk taking.