Abstract
We find profitability measures fail to explain future stock returns of China’s A-shares. In addition, although profitability growth significantly and positively correlates with the cumulative stock return in the following year, profitability measures do not predict profitability growth, suggesting the lack of profitability sustainability helps explain the missing profitability premium. Furthermore, we also find that firms with higher profitability have lower stock price delay, are more liquid, and attract more investor attention. Because we find that investors require a premium for holding stocks with higher market frictions and that profitability measures significantly and negatively predict the component of future stock returns explained by market frictions, our results suggest that the required premium for holding stocks with market frictions may conceal the potential profitability premium. Overall, our results suggest both the unsustainable profitability and lower price delay premium of firms with higher profitability are responsible for the missing profitability premium for China’s A-shares. The policy implications of the findings are discussed.
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