Does Higher Investments Necessarily Reduce Stock Returns?

Previous studies find corporate investments negatively predict firm performance and stock returns. Using data from the Chinese A-share stock market, we find firms that substantially increase their investments have higher, rather than lower, subsequent stock returns. This effect persists after controlling for important price factors such as size, value, momentum, and turnover. Further analysis shows that this effect is more pronounced among large firms, low BM firms, profitable firms and high-growth industries. We offer a unified explanation for the contradictory findings: The investment-stock return relation depends on whether return to capital is decreasing or increasing. We find evidence of increasing returns to capital in last two decades in China, which implies more investment leads to higher rather than lower profits and consequently higher stock returns