The Basic Concepts Related to Returns on Earnings Regressions

This paper revisits the familiar problem of specifying empirical regressions of returns on price-normalised earnings variables. The focus is on relevant organising concepts related to the right-hand-side variables / regressors. Issues raised are: (i) the crucial role of assuming market efficiency; (ii) why the notion of “unexpected earnings explain unexpected returns” obscures rather than highlights the nature of the regression specification; (iii) why a regression specification benefits from the inclusion of the prior period's earnings in addition to contemporaneous earnings; (iv) why the start-of-period book value-to-price ratio should be included as a regressor; (v) why an hypothesis relating accounting data, such as eps and bvps, to price per share precedes a regression on returns specification; (vi) how the analysis extends to include analysts' eps expectations, and changes in eps expectations, as (price-normalised) regressors.