The Rising Importance of Aggregate Earnings

This paper develops a comprehensive framework that examines the earnings-returns relation based on cross-sectional and time-series variations. While the literature documents a declining relation over time using a cross-sectional analysis, an analysis of firm-level time series shows a slightly increasing trend. Decomposing earnings into firm-specific and systematic components demonstrates that firm stock returns exhibit an increasing (declining) relation with systematic earnings (firm-specific) earnings. The rising importance of systematic earnings is attributable to the increase in the number and scale of financial institutions and to non-operating items among non-financial firms. Although prior studies show that non-operating items exhibit lower earnings persistence over time, our results suggest that the systematic component of non-operating items is increasingly associated with firm valuation and enhances the ability to predict future firm-level operating earnings. These findings highlight the importance of considering time-series, in addition to cross-sectional, analyses to draw conclusions about the earnings-returns relation