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This study identifies earnings yield as a measure offinancial performance that is based on a firm’s ability to sell profitablegoods. It excludes the irrationality that can confound market-based measures offinancial performanceby emphasizinga firm’s ability to earn profits as the indicator of superior performance. Forthe full sample, the differential effects of earnings yield on return onassets, return on equity, stock returns, economic value added and the equitymultiplier are determined for firms of different size and volatility. Theanalysis is conducted both across industries and within the oil and gas,computer software, biotechnology and retail industries. For the full sample ofNASDAQ stocks from 2010-2014, earnings yield significantly explained return onassets, return on equity, stock returns, economic value added and the equitymultiplier beyond book value and book to market. The influence of earningsyield on return on assets was predictable with linear relationships andautocorrelated residuals, while that for small firms was unpredictable withnonlinear relationships between earnings yield and all outcomes withheteroscedastic residuals. In the oil and gas industry, small producers withlow market risk and high firm-specific risk, i.e. drillers in new locations with existing technology, found thatearnings yield was related to all outcome measures, while large, high-marketrisk firms, or drillers using the new shale rock techniques strove foroperational efficiency through higher return on assets and return on equity.Market risk demarcates small biotechnology firms with those with low marketrisk demonstrating the explanation of return on assets by earnings yield, whileearnings yield is significantly related to economic value added for high market riskfirms. In large biotechnology firms, earnings yield was significantly relatedto all outcomes. Similar results were obtained for the computer softwareindustry. Retail is in retrenchment with small retailers selling traditionalproduct lines emphasizing return on assets or being operationally efficient forsurvival, while large retailers borrow against large-scale investments inassets, as shown by the significant explanation of the equity multiplier byearnings yield. It may be concluded that earnings yield measures multipledimensions of financial performance for firms of different size and volatilitylevels in multiple industries. For small firms, the ability of earnings yieldto measure the productivity of capital through economic value added isnoteworthy. For large firms, earnings yield is particularly effective inpredicting operational efficiency or return on assets.

KEYWORDS

Earnings Yield, Stock Returns, Economic Value Added, Equity Multiplier

Cite this paper

Abraham, R. , Harris, J. and Auerbach, J. 2017 Earnings Yield as a Predictor of Return on Assets, Return on Equity, Economic Value Added and the Equity Multiplier. Modern Economy, 8, 10-24. doi: 10.4236-me.2017.81002.





Author: Rebecca Abraham, Judith Harris, Joel Auerbach

Source: http://www.scirp.org/



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