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Extrapolative biases and expectations of growth: A re-examination of the accruals and forecast to price anomalies
This paper develops an empirical proxy to capture the markets' expectations of growth and the propensity of investors to extrapolate recent extreme growth too far into the future. The construction of the empirical proxy is predicated on the extant literature that shows that recent sales growth and yield surrogates reflect markets' expectations of growth, which have been found to be too extreme. The paper also re-examines two recent asset pricing anomalies published in the accounting literature—the asset scaled accruals and forecast to price anomalies—in light of the likely connection of accruals to realized growth and the forecast to price ratio acting as a yield surrogate and impounding expectations of growth. I find that the empirical proxy, constructed from recent sales growth and the cash flow to price ratio, produces large abnormal returns to simple hedge strategies. Moreover, the proxy subsumes other expected growth proxies such as the earnings yield, the cash flow to price ratio, weighted average sales growth, and the IBES long-term growth forecast in its ability to explain future returns. Lastly, I find that employing the expected-growth proxy in multivariate returns regressions suggests that overly extreme expectations of growth may be a partial explanation for the abnormal returns generated to hedge portfolios based on the magnitudes of asset-scaled accruals and the forecast to price ratio.
Brown, William Douglas, "Extrapolative biases and expectations of growth: A re-examination of the accruals and forecast to price anomalies" (2002). Doctoral Dissertations Available from Proquest. AAI3039341.