Aggregate earnings, firm-level earnings, and expected stock returns

This paper provides an analysis of the predictability of stock returns using market-, industry-, and firm-level earnings. Contrary to Lamont (1998), we find that neither dividend payout ratio nor the level of aggregate earnings can forecast the excess market return. We show that these variables do not have robust predictive power across different stock portfolios and sample periods. In contrast to the aggregate-level findings, earnings yield has significant explanatory power for the time-series and cross-sectional variation in firm-level stock returns and the 48 industry portfolio returns. The mean reversion of stock prices as well as the earnings' correlation with expected stock returns are responsible for the forecasting power of earnings yield. These results are robust after controlling for book-to-market, size, price momentum, and post-earnings announcement drift. At the aggregate level, the information content of firm-level earnings about future cash flows is diversified away and higher aggregate earnings do not forecast higher returns.