Long-term Discount Rates in the Cross Section of Stocks

Long-term discount rate is different from short-term expected return. Long-term discount rate determines the level of equity valuation, whereas short-term return reflects the change in valuation. Long-term discount rate is relevant to corporate managers as it summarizes a firm's financing cost, while short-term expected return concerns investors who can trade dynamically. By applying the Gordon growth model and its two-stage variant, I empirically measure how long-term discount rates are correlated with various firm characteristics. I show that the relation between long-term discount rates and firm characteristics can be very different from that of the short-term expected returns. Characteristics predicting short-term returns do not always line up with long-term discount rates and vice versa. My findings highlight the mismatch between long-term discount rates and short-term expected returns, and document how firm characteristics are correlated with equity valuation levels