Does Firm Value Move Too Much to be Justified by Subsequent Changes in Cash Flow?

Abstract

The appropriate measure of cash flow for valuing corporate assets is net payout, which is the sum of dividends, interest, and net repurchases of equity and debt. Variation in net payout yield, the ratio of net payout to asset value, is mostly driven by movements in expected cash flow growth, instead of movements in discount rates. Net payout yield is less persistent than dividend yield and implies much smaller variation in long-horizon discount rates. Therefore, movements in the value of corporate assets can be justified by changes in expected future cash flow. AbstractThe appropriate measure of cash flow for valuing corporate assets is net payout, which is the sum of dividends, interest, and net repurchases of equity and debt. Variation in net payout yield, the ratio of net payout to asset value, is mostly driven by movements in expected cash flow growth, instead of movements in discount rates. Net payout yield is less persistent than dividend yield and implies much smaller variation in long-horizon discount rates. Therefore, movements in the value of corporate assets can be justified by changes in expected future cash flow.JEL classification: G12; G32; G35

Comment on “Growth uncertainty, generalized disappointment aversion and production-based asset pricing”

“…In particular, Larrain and Yogo (2008) use data from the Flow of Funds accounts, as well as Compustat to construct aggregate historical asset returns (i.e., the return to the claim on all firm payouts). In the 1926-2004 Flow of Funds sample, they compute this return volatility to be 12.2%.…”

Analyst valuation and corporate value discovery

“…This measure captures the idea that there are smaller forecast errors in low return volatility firms. Larraina and Yogo (2008) find that the variation in net payout yield, the ratio of net payout to asset value, is mostly driven by movements in expected cash flow growth, instead of movements in discount rates. Chen and Zhao (2009) note that cash flow news dominates at the firm level but discount rate news dominates at the aggregate level.…”

Credit conditions and stock return predictability

“…Boudoukh et al (2007), Larrain and Yogo (2008), Robertson and Wright (2006), and Bansal and Yaron (2011) document that payout yields (as opposed to simple dividend yields) derived from dividends, repurchases, and issuances are robust predictors of excess stock returns. Moreover, Goyal and Welch (2008) find that ntis, which measures equity issuing and repurchasing (plus dividends) relative to the price level, has good in-sample performance, but a negative out-of-sample adjusted R 2 .…”

“…Asset pricing models with time-varying discount rates, such as the Campbell and Cochrane (1999) model, would typically imply investors require higher expected returns in bad times. However, a cash flow component could be important too as captured for example in the Bansal and Yaron (2004) model and empirically studied in Bansal and Yaron (2011) and Larrain and Yogo (2008) using measures of total cash flows. The source of the predictability of Standards is now explored to better understand the negative coefficient.…”

“…Recent examples include Lettau and Ludvigson (2005), Larrain and Yogo (2008), Bansal and Yaron (2011), 2 See Berlin (2009) for a survey of models that explain bank lending cycles. Garrett andPriestley (2012), Bollerslev et al (2015), and Maio and Santa-Clara (2015).…”