Size and Book-to-Market Factors in Earnings and Returns

A study examines whether the behavior of stock prices, in relation to size and book-to-market-equity (BE/ME), reflects the behavior of earnings. Consistent with rational pricing, high BE/ME signals persistent poor earnings and low BE/ME signals strong earnings. Moreover, stock prices forecast the reversion of earnings growth observed after firms are ranked on size and BE/ME. Finally, there are market, size, and BE/ME factors in earnings like those in returns. The market and size factors in earnings help explain those in returns, but the study finds no link between BE/ME factors in earnings and returns. Given that there are reliable common factors in earnings much like those in returns, the failure to find more systematic evidence that the common factors in earnings drive returns is perhaps due to noisy measures of shocks to expected earnings.