Earnings Asan Explanatory Variable for Returns

Abstract

In this paper we investigate whether the level of earnings divided by price at the beginning of the return period is relevant for evaluating earnings/returns associations.' The primary model motivating this research relies on the idea that book value (owners' equity) and market value are both stock variables indicating the wealth of the firm's equity holders. The related flow variables (after adjusting for dividends) are, respectively, earnings divided by price at the beginning of the return period (A/P-1) and market returns. It then follows that earnings divided by beginning of period price should be associated with returns. Although models based on a relation between market value and book value are used occasionally in the accounting research literature (see, for example, Landsman [1986], Harris and Ohlson [1987], and Barth