TITLE:
Earnings Yield as a Predictor of Return on Assets, Return on Equity, Economic Value Added and the Equity Multiplier
AUTHORS:
Rebecca Abraham, Judith Harris, Joel Auerbach
KEYWORDS:
Earnings Yield, Stock Returns, Economic Value Added, Equity Multiplier
JOURNAL NAME:
Modern Economy,
Vol.8 No.1,
January
9,
2017
ABSTRACT: This study identifies earnings yield as a measure of
financial performance that is based on a firm’s ability to sell profitable
goods. It excludes the irrationality that can confound market-based measures of
financial performance by emphasizing
a firm’s ability to earn profits as the indicator of superior performance. For
the full sample, the differential effects of earnings yield on return on
assets, return on equity, stock returns, economic value added and the equity
multiplier are determined for firms of different size and volatility. The
analysis is conducted both across industries and within the oil and gas,
computer software, biotechnology and retail industries. For the full sample of
NASDAQ stocks from 2010-2014, earnings yield significantly explained return on
assets, return on equity, stock returns, economic value added and the equity
multiplier beyond book value and book to market. The influence of earnings
yield on return on assets was predictable with linear relationships and
autocorrelated residuals, while that for small firms was unpredictable with
nonlinear relationships between earnings yield and all outcomes with
heteroscedastic residuals. In the oil and gas industry, small producers with
low market risk and high firm-specific risk, i.e. drillers in new locations with existing technology, found that
earnings yield was related to all outcome measures, while large, high-market
risk firms, or drillers using the new shale rock techniques strove for
operational efficiency through higher return on assets and return on equity.
Market risk demarcates small biotechnology firms with those with low market
risk demonstrating the explanation of return on assets by earnings yield, while
earnings yield is significantly related to economic value added for high market risk
firms. In large biotechnology firms, earnings yield was significantly related
to all outcomes. Similar results were obtained for the computer software
industry. Retail is in retrenchment with small retailers selling traditional
product lines emphasizing return on assets or being operationally efficient for
survival, while large retailers borrow against large-scale investments in
assets, as shown by the significant explanation of the equity multiplier by
earnings yield. It may be concluded that earnings yield measures multiple
dimensions of financial performance for firms of different size and volatility
levels in multiple industries. For small firms, the ability of earnings yield
to measure the productivity of capital through economic value added is
noteworthy. For large firms, earnings yield is particularly effective in
predicting operational efficiency or return on assets.