Cashflow Risk, Systematic Earnings Revisions, and the Cross-Section of Stock Returns
Abstract
The returns of stocks are driven by changes in their expected cashflow. Using revisions in analyst earnings forecasts over a range of future maturities, we construct an analyst earnings beta that measures the covariance between the cashflow innovations of an asset with those of the market. A higher analyst earnings beta implies greater sensitivity to market-wide revisions in expected cashflows, and therefore higher systematic risk. Empirically, value stocks and small stocks have larger analyst earnings betas than growth stocks and large stocks respectively. Consequently, the value and size premiums are consistent with the cashflow risk arising from revisions in analyst earnings forecasts. During the 1984 to 2005 sample period, 57.2% of the variation in book-to-market and size portfolio returns is attributable to analyst earnings betas.