Profitability, investment and average returns

Valuation theory says that expected stock returns are related to three variables: the book-to-market equity ratio (B-t/M-t), expected profitability, and expected investment. Given B-t/M-t and expected profitability, higher expected rates of investment imply lower expected returns. But controlling for the other two variables, more profitable firms have higher expected returns, as do firms with higher B-t/M-t. These predictions are confirmed in our tests. (c) 2006 Elsevier B.V. All rights reserved.