Persistence of Abnormal Earnings and Differential Growth Rates in the Market and Book Value of Equity
In this paper, I examine the relationship between the real performance of firms in the product market and their financial performance in the stock markets. I find, by using a combination of time series and cross-sectional data of 1046 U.S. firms in the period of (2000-2021), that the persistence of abnormal earnings is one of the driving forces in long-run market valuation. In fact, the persistence of positive abnormal earnings leads to higher growth rates in the market value of equity than in book values, which in turn contributes to widening the gap between market value and book value, but up to a certain point, as the difference-in-difference dynamic analysis indicates. This result is generally consistent with previous empirical evidence that market stock prices are sensitive to expected future earnings and the presence of above-average returns on equity. Firms that continue to generate successive abnormal earnings for years will gain more confidence from investors, which has a positive impact on their market valuation. In addition to abnormal earnings, I find that investment rates, leverage ratio, dividend yield, and earnings variability are among the major variables that positively affect the growth differential between market value and book value of equity. In addition, firms with higher price-earnings ratios or lower earnings variability exhibit higher differential growth rates in market valuation