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New Evidence on the Relation between the Enterprise Multiple and Average Stock Returns

Published online by Cambridge University Press:  07 June 2011

Tim Loughran  and
Jay W. Wellman
Tim Loughran
Affiliation:
Mendoza College of Business, University of Notre Dame, 245 Mendoza College of Business, Notre Dame, IN 46556. [email protected]
Jay W. Wellman
Affiliation:
School of Hotel Administration, Cornell University, Ithaca, NY 14853. [email protected]
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Abstract

Practitioners increasingly use the enterprise multiple (EM) as a valuation measure. EM is (equity value + debt + preferred stock – cash) / (EBITDA). We document that EM is a strong determinant of stock returns. Following Fama and French (1993) and Chen, Novy-Marx, and Zhang (2010), we create an EM factor that generates a return premium of 5.28% per year. We interpret EM as a proxy for the discount rate. Firms with low EM values appear to have higher discount rates and higher subsequent stock returns than firms with high EM values.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 6 , December 2011 , pp. 1629 - 1650
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

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