Rating to economic profit: Valuation properties, implementation issues, and the justification of target prices

Figures & data

Table 1. Data collection process.

Panel A. Data Collection Criteria				Number of Firms
Initial Number of Firms				2,670
(-) Number of firms that do not have a fiscal year-end date between December 20 and January 10				(441)
Final Number of Sample Firms				2,229
Panel B. Data from 2010 to 2021
		Missing Values
Variables	Initial Number of Observations	Non-Available Information	Negative P/B	Negative ROE	Negative REP	Number of Observations in Final Sample
REP_1	19,035	5,981	601	944	-	11,509
REP_2	19,035	5,981	601	944	-	11,509
REP_3	19,035	5,981	601	944	704	10,805
REP_4	19,035	5,981	601	944	860	10,649
REP_5	19,035	5,981	601	944	-	11,509
REP_6	19,035	5,981	601	944	704	10,805
TP/P	19,035	7,468	-	-	-	11,567

Note: The Table describes our data collection process. We apply a filtering process on Thomson Reuters Eikon platform (Datastream) so as to restrict our initial sample to include equities from active and dead / inactive firms that are listed on “NYSE” and their financials are expressed in US$. Our initial sample consists of 2,670 US-listed firms. To end up to a final sample of 2,229 firms, we exclude firms that do not have fiscal year end dates between 20 December and 10 January (approx. similar to the calendar year end date). The initial number of firm-year observations in our sample is 19,035. We have some missing values due to the limited availability of data ($\mathrm{ROE},P/B,\mathrm{TP}/P$). We also choose to restrict our sample by excluding firm-year observations with negative Price-to-Book ($P/B$) and Return-on-Equity $\left(\mathrm{ROE}\right)$ ratios. After $\mathrm{REP}$'s calculations, we further exclude all negative values of this ratio that are due to low $\mathrm{ROE}$ compared to growth (in cases where$g$= 2.936 percent). In this way, we end up with a final sample that ranges from 10,649 to 11,509 firm-year observations for our four $\mathrm{REP}$ metrics and 11,567 values for $\mathrm{TP}/P$ (see last Column, Panel B). Variable definitions are provided in Table 2.

Table 2. Variable definitions.

Variable name	Variable definition
$\mathrm{dREP}\mathrm{\_}1$	A dummy variable that takes the value of 1 when $\mathrm{REP}\mathrm{\_}1$ > 1 and the value of zero when 0 < $\mathrm{REP}\mathrm{\_}1$ < 1.
$\mathrm{dREP}\mathrm{\_}2$	A dummy variable that takes the value of 1 when $\mathrm{REP}\mathrm{\_}2$ > 1 and the value of zero when 0 < $\mathrm{REP}\mathrm{\_}2$ < 1.
$\mathrm{dREP}\mathrm{\_}3$	A dummy variable that takes the value of 1 when $\mathrm{REP}\mathrm{\_}3$ > 1 and the value of zero when 0 < $\mathrm{REP}\mathrm{\_}3$ < 1.
$\mathrm{dREP}\mathrm{\_}4$	A dummy variable that takes the value of 1 when $\mathrm{REP}\mathrm{\_}4$ > 1 and the value of zero when 0 < $\mathrm{REP}\mathrm{\_}4$ < 1.
$\mathrm{dREP}\mathrm{\_}5$	A dummy variable that takes the value of 1 when $\mathrm{REP}\mathrm{\_}5$ > 1 and the value of zero when 0 < $\mathrm{REP}\mathrm{\_}5$ < 1.
$\mathrm{dREP}\mathrm{\_}6$	A dummy variable that takes the value of 1 when $\mathrm{REP}\mathrm{\_}6$ > 1 and the value of zero when 0 < $\mathrm{REP}\mathrm{\_}6$ < 1.
$g$	Long-term growth rate; it is defined as the long-term (average) US GDP real growth rate (USWD3QBGR) from 1961 to 2021.
$g_{\mathrm{sp}}$	The market-implied growth rate from $\mathrm{REP}$ ratio.
$g_{\mathrm{tp}}$	The target-price-implied growth rate from $\mathrm{REP}$ ratio.
$\mathrm{ROE}$	Return-on-Equity defined as 12-month Forward Earnings Per Share (EPS1FD12) on 1 April of the subsequent year, divided by the Common Equity (WC03501) at the fiscal year end date. The Common Equity is scaled by the Number of Common Shares Outstanding (WC05301) to produce the book value per share.
$\mathrm{Ri}$	One-year forward stock return is calculated as the one-year forward percentage change of the Return Index (RI).
$r_{\mathrm{CAPM}}$	Cost of Equity is calculated from Fama and French (1997) as industry-specific risk premiums plus the risk-free rate. We use the 10-Year Treasury bond yield (USYIETBNR) on 1 April of the subsequent year as the risk-free rate and the full-period CAPM-based industry-specific risk premiums (from Fama and French, 1997).
$r_{\mathrm{tf}}$	Cost of Equity is calculated from Fama and French (1997) as industry-specific risk premiums plus the risk-free rate. We use the 10-Year Treasury bond yield (USYIETBNR) on 1 April of the subsequent year as the risk-free rate and the Three-Factor-model-based industry-specific risk premiums (from Fama and French, 1997).
$r_1$	The market-implied cost of equity from the $\mathrm{REP}$ ratio that assumes zero future growth.
$r_2$	The market-implied cost of equity from the $\mathrm{REP}$ ratio that assumes a constant future growth rate g.
$r_3$	The target-price-implied cost of equity from the $\mathrm{REP}$ ratio that assumes zero future growth.
$r_4$	The target-price-implied cost of equity from the $\mathrm{REP}$ ratio that assumes a constant future growth rate g.
$\mathrm{REP}$	In all $\mathrm{REP}$ specifications, the numerator of the ratio is defined as equal to the Market Value (MV) on 1 April of the subsequent year to the book value of Common Equity (WC03501) at the company’s fiscal year end date. The expected Return on Equity $\left(\mathrm{ROE}\right)$ and the cost of equity estimates in the denominator of all ratios are defined above. The REP formulas are described in Section 4.
$\mathrm{REP}\mathrm{\_}1$	In this REP specification, we do not take into consideration future growth prospects. We use $r_{\mathrm{CAPM}}$ as cost of equity.
$\mathrm{REP}\mathrm{\_}2$	In this REP specification, we do not take into consideration future growth prospects. We use $r_{\mathrm{tf}}$ as cost of equity.
$\mathrm{REP}\mathrm{\_}3$	In this REP specification, we incorporate a growth factor $g$. We use $r_{\mathrm{CAPM}}$ as cost of equity.
$\mathrm{REP}\mathrm{\_}4$	In this REP specification, we incorporate a growth factor $g$. We use $r_{\mathrm{tf}}$ as cost of equity.
$\mathrm{REP}\mathrm{\_}5$	In this REP specification, we do not take into consideration future growth prospects. We use $r_e$ = 9 percent as cost of equity.
$\mathrm{REP}\mathrm{\_}6$	In this REP specification, we incorporate a growth factor $g$. We use $r_e$ = 9 percent as cost of equity.
$\mathrm{TP}/P$	Target Price-to-Price ratio is defined as the I/B/E/S Target Price Mean (PTMN) to I/B/E/S Price (IBP).
$\mathrm{Pseudo}-T{P}_1$	The pseudo target price from the $\mathrm{REP}$ ratio that ignores future growth opportunities and employs $r_{\mathrm{CAPM}}$ as the cost of equity.
$\mathrm{Pseudo}-T{P}_2$	The pseudo target price from the $\mathrm{REP}$ ratio that ignores future growth opportunities and employs $r_{\mathrm{tf}}$ as the cost of equity.
$\mathrm{Pseudo}-T{P}_3$	The pseudo target price from the $\mathrm{REP}$ ratio that assumes a constant future growth rate and uses the cost of equity $r_{\mathrm{CAPM}}$.
$\mathrm{Pseudo}-T{P}_4$	The pseudo target price from the $\mathrm{REP}$ ratio that assumes a constant future growth rate and uses the cost of equity $r_{\mathrm{tf}}$.
$\mathrm{Pseudo}-T{P}_5$	The pseudo target price from the $\mathrm{REP}$ ratio that ignores future growth opportunities and employs $r_e$ = 9 percent as the cost of equity.
$\mathrm{Pseudo}-T{P}_6$	The pseudo target price from the $\mathrm{REP}$ ratio that assumes a constant future growth rate and uses the cost of equity of $r_e$ = 9 percent.

Note: All data are from Datastream and their datatypes are given in parentheses.

Table 3. Descriptive statistics of REP metrics.

Valuation Ratios	Number of Obs	Mean	Median	Standard Deviation
$\mathrm{REP}\mathrm{\_}1$	11,509	1.96	1.232	2.879
$\mathrm{REP}\mathrm{\_}2$	11,509	2.179	1.371	3.203
$\mathrm{REP}\mathrm{\_}3$	10,805	1.635	0.951	2.67
$\mathrm{REP}\mathrm{\_}4$	10,649	1.956	1.143	3.188
$\mathrm{REP}\mathrm{\_}5$	11,509	2.227	1.433	3.19
$\mathrm{REP}\mathrm{\_}6$	10,805	1.982	1.216	3.028

Note: The table provides the number of observations, and the mean, median and standard deviation of six alternative REP measures that we use in our empirical analysis: i) $\mathrm{REP}\mathrm{\_}1$ (zero growth, $r_{\mathrm{CAPM}}$); ii) $\mathrm{REP}\mathrm{\_}2$ (zero growth,$r_{\mathrm{tf}}$); iii) $\mathrm{REP}\mathrm{\_}3$ ($g$ = long-term US GDP real growth rate, $r_{\mathrm{CAPM}}$); iv) $\mathrm{REP}\mathrm{\_}4$($g$ = long-term US GDP real growth rate, $r_{\mathrm{tf}}$) v) $\mathrm{REP}\mathrm{\_}5$ (zero growth,$r_e=9\text{\%}$); vi) $\mathrm{REP}\mathrm{\_}6$ ($g$ = long-term US GDP real growth rate, $r_e=9\text{\%}$). Variable definitions are provided in Table 2.

Table 4. Descriptive statistics of REP components.

Panel A. Accounting and Financial Components	Full Sample (Median)
Price to Book Value (P/B) Multiple	2.01
Return on Equity (ROE)	13%
a. Cost of Equity from CAPM $\left(r_{\mathrm{CAPM}}\right)$	7.9%
b. Cost of Equity from Three-Factor-Model $\left(r_{\mathrm{tf}}\right)$	8.7%
Panel B. Implied Growth Rates
Market-Implied Growth Rates:
a.$r_{\mathrm{CAPM}}$	3.3%
b.$r_{\mathrm{tf}}$	4.6%
c. r = 9%	5.1%
Target-Price-Implied Growth Rates:
a.$r_{\mathrm{CAPM}}$	3.8%
b. $r_{\mathrm{tf}}$	5.1%
c. $r=9\text{\%}$	5.7%
Panel C. Implied Cost of Equity
Market-Implied Cost of Equity:
a. g = 0	6.2%
b. g = 2.936%	7.7%
Target-Price-Implied Cost of Equity:
a. g = 0	5.5%
b. g = 2.936%	7.3%

Note: Panel A reports median values for the following four financial ratios across all years of our sample: i) Price-to-Book (P/B) multiple; ii) Return-on-Equity ($\mathrm{ROE}$); iii) Cost of Equity ($r_{\mathrm{CAPM}}$) calculated as the risk-free rate plus the CAPM-based industry-specific risk premium from Fama and French (1997); and iv) Cost of Equity ($r_{\mathrm{tf}}$), calculated as the risk-free rate plus the Three-Factor-model-based industry-specific risk premium from Fama and French (1997). Panel B provides the median values of the market and target price implied growth rates by reverse-engineering the Rating to Economic Profit ($\mathrm{REP}$) ratio. We use two Cost of Equity ($r_{\mathrm{CAPM}}$_, $r_{\mathrm{tf}}$) estimates based on Fama and French (1997) and one fixed cost of equity $r_e=9\text{\%}$. Similarly, Panel C reports the median values of the market and target price implied cost of equity estimates from the alternative versions of the $\mathrm{REP}$ formula that either ignore or incorporate future growth opportunities. Variable definitions are provided in Table 2.

Table 5. Formal empirical assessment of mean differences in $\mathit{TP}/\mathit{P}$ and $\mathit{Ri}$.

Panel A. $\mathit{REP}\mathrm{\_}1$ (zero growth, ${\mathit{r}}_{\mathit{C}\mathrm{APM}}$)
		$\mathrm{REP}$	$\mathrm{TP}/P$	$\mathrm{Ri}$	$\mathrm{TP}/P$: Differences between two groups		$\mathrm{RI}$: Differences between two groups
Group	Num. of Obs	Mean	Mean	Mean	t-statistic	p-value	t-statistic	p-value
0 < $\mathrm{REP}\mathrm{\_}1$< 1	3,949	0.70	1.37	0.22	24.56	0.000	6.1	0.000
$\mathrm{REP}\mathrm{\_}1$ >  1	7,419	2.62	1.13	0.14
Panel B. $\mathit{REP}\mathrm{\_}2$ (zero growth, ${\mathit{r}}_{\mathit{t}f}$)
		$\mathrm{REP}$	$\mathrm{TP}/P$	$\mathrm{Ri}$	$\mathrm{TP}/P$: Differences between two groups		$\mathrm{RI}$: Differences between two groups
Group	Num. of Obs	Mean	Mean	Mean	t-statistic	p-value	t-statistic	p-value
0< $\mathrm{REP}\mathrm{\_}2$< 1	3,125	0.68	1.43	0.22	28.07	0.000	5.64	0.000
$\mathrm{REP}\mathrm{\_}2$ >  1	8,243	2.73	1.13	0.14
Panel C. $\mathit{REP}\mathrm{\_}3$ (g = long-term US GDP real growth rate,${\mathit{r}}_{\mathit{C}\mathrm{APM}}$)
		$\mathrm{REP}$	$\mathrm{TP}/P$	$\mathrm{Ri}$	$\mathrm{TP}/P$: Differences between two groups		$\mathrm{RI}$: Differences between two groups
Group	Num. of Obs	Mean	Mean	Mean	t-statistic	p-value	t-statistic	p-value
0< $\mathrm{REP}\mathrm{\_}3$< 1	5,706	0.63	1.28	0.19	16.45	0.0000	5.51	0.000
$\mathrm{REP}\mathrm{\_}3$ >  1	4,984	2.78	1.13	0.13
Panel D. $\mathit{REP}\mathrm{\_}4$ (g = long-term US GDP real growth rate, ${\mathit{r}}_{\mathit{t}f}$)
		$\mathrm{REP}$	$\mathrm{TP}/P$	$\mathrm{Ri}$	$\mathrm{TP}/P$: Differences between two groups		$\mathrm{RI}$: Differences between two groups
Group	Num. of Obs	Mean	Mean	Mean	t-statistic	p-value	t-statistic	p-value
0< $\mathrm{REP}\mathrm{\_}4$< 1	4,267	0.65	1.33	0.20	21.72	0.000	5.6	0.000
$\mathrm{REP}\mathrm{\_}4$ >  1	6,269	2.84	1.13	0.13
Panel E. $\mathit{REP}\mathrm{\_}5$ (g = zero growth, ${\mathit{r}}_{\mathit{e}}$ = 9%)
		$\mathrm{REP}$	$\mathrm{TP}/P$	$\mathrm{Ri}$	$\mathrm{TP}/P$: Differences between two groups		$\mathrm{RI}$: Differences between two groups
Group	Num. of Obs	Mean	Mean	Mean	t-statistic	p-value	t-statistic	p-value
0< $\mathrm{REP}\mathrm{\_}5$< 1	2,548	0.72	1.49	0.24	31.14	0.000	6.85	0.000
$\mathrm{REP}\mathrm{\_}5$ >  1	8,820	2.65	1.14	0.14
Panel F. $\mathit{REP}\mathrm{\_}6$ (g = long-term US GDP real growth rate, ${\mathit{r}}_{\mathit{e}}$ = 9%)
		$\mathrm{REP}$	$\mathrm{TP}/P$	$\mathrm{Ri}$	$\mathrm{TP}/P$: Differences between two groups		$\mathrm{RI}$: Differences between two groups
Group	Num. of Obs	Mean	Mean	Mean	t-statistic	p-value	t-statistic	p-value
0< $\mathrm{REP}\mathrm{\_}6$< 1	3,674	0.70	1.36	0.21	24.70	0.000	6.18	0.000
$\mathrm{REP}\mathrm{\_}6$ >  1	7,016	2.65	1.13	0.14

Note: The table reports the mean values of target price boldness ($\mathrm{TP}/P$) and one-year forward stock return ($\mathrm{Ri})$for each $\mathrm{REP}$ group of undervalued and overvalued stocks. In each Panel, the sample of firm-year observations is divided in two groups based on whether$\mathrm{REP}$ takes values between zero and one (undervalued stocks), or higher than one (overvalued stocks). To increase the robustness of our work, we employ six different Rating to Economic Profit (REP) metrics: $\mathrm{REP}\mathrm{\_}1$ (zero growth, $r_{\mathrm{CAPM}}$); ii) $\mathrm{REP}\mathrm{\_}2$ (zero growth,$r_{\mathrm{tf}}$); iii) $\mathrm{REP}\mathrm{\_}3$ (g = long-term US GDP real growth rate, $r_{\mathrm{CAPM}}$); iv) REP_4 (g = long-term US GDP real growth rate, $r_{\mathrm{tf}}$); v) $\mathrm{REP}\mathrm{\_}5$ (zero growth,$r_e=9\text{\%}$); and, vi) REP_6 (g = long-term US GDP real growth rate, $r_e=9\text{\%}$).The mean difference tests in TP/P and $\mathrm{Ri}$are performed by using t-test. Variable definitions are provided in Table 2.

Table 6. One-year forward stock returns of $\mathit{REP}$ quintile portfolios.

$\mathit{Ri}\mathrm{on}\mathrm{REP}$ Portfolios:	$\mathit{Ri}$(Q1)	$\mathit{Ri}($Q2)	$\mathit{Ri}$(Q3)	$\mathit{Ri}$(Q4)	$\mathit{Ri}$(Q5)	Upper – Lower:
	Mean	Mean	Mean	Mean	Mean	t-statistic	p-value
$\mathrm{REP}\mathrm{\_}1$	21.6%	15.3%	13.2%	10.9%	11.9%	6.00	0.000
$\mathrm{REP}\mathrm{\_}2$	19.8%	17.6%	12.2%	11.6%	11.7%	6.00	0.000
$\mathrm{REP}\mathrm{\_}3$	19.0%	18.0%	13.7%	10.2%	12.2%	4.19	0.000
$\mathrm{REP}\mathrm{\_}4$	18.4%	17.8%	14.6%	10.7%	11.4%	4.35	0.000
$\mathrm{REP}\mathrm{\_}5$	21.4%	15.2%	12.3%	11.2%	12.9%	5.11	0.000
$\mathrm{REP}\mathrm{\_}6$	20.3%	15.9%	12.8%	11.8%	12.2%	4.77	0.000

Note: The Table reports the mean values of one-year forward stock returns $\mathrm{Ri}$ for each $\mathrm{REP}$ quantile portfolios ($\mathrm{REP}>0$). To increase the robustness of our work, we employ the six different Rating to Economic Profit (REP) metrics: $\mathrm{REP}\mathrm{\_}1$ (zero growth, $r_{\mathrm{CAPM}}$); ii) $\mathrm{REP}\mathrm{\_}2$ (zero growth,$r_{\mathrm{tf}}$); iii) $\mathrm{REP}\mathrm{\_}3$ (g = long-term US GDP real growth rate, $r_{\mathrm{CAPM}}$); iv) REP_4 (g = long-term US GDP real growth rate, $r_{\mathrm{tf}}$); v) $\mathrm{REP}\mathrm{\_}5$ (zero growth,$r_e=9\text{\%}$); and, vi) REP_6 (g = long-term US GDP real growth rate, $r_e=9\text{\%}$). A t-test is conducted for the differences between the upper and the lower quantiles. Variable definitions are provided in Table 2.

Table 7. The explanation of concurrent stock market valuations by pseudo-target prices based on $\mathit{REP}$.

Independent variable	$\mathit{P}\left(\mathit{M}1\right)$		$\mathit{P}\left(\mathit{M}2\right)$		$\mathit{P}\left(\mathit{M}3\right)$		$\mathit{P}\left(\mathit{M}4\right)$		$\mathit{P}\left(\mathit{M}5\right)$		$\mathit{P}\left(\mathit{M}6\right)$
	Coefficient	p-value	Coefficient	p-value	coefficient	p-value	coefficient	p-value	coefficient	p-value	coefficient	p-value
$\mathit{Pseudo}-\mathrm{TP}1$	0.930***	0.000
$\mathit{Pseudo}-\mathrm{TP}2$			0.810***	0.000
$\mathit{Pseudo}-\mathrm{TP}3$					0.543***	0.000
$\mathit{Pseudo}-\mathrm{TP}4$							0.477***	0.000
$\mathit{Pseudo}-\mathrm{TP}5$									1.185***	0.000
$\mathit{Pseudo}-\mathrm{TP}6$											0.858***
Intercept	13.39***	0.000	19.3***	0.000	21.83***	0.000	27.72***	0.000	10.59***	0.000	16.24***	0.000
Number of Obs.	11,085		11,085		10,494		10,330		11,085		10,494
R-squared	0.895		0.888		0.874		0.871		0.903		0.892

Note: The table reports the results of our OLS regression analysis with firm/year fixed effects, that assesses the ability of the REP ratio to explain the contemporaneous stock market valuations of our sample firms. The Table presents six model specifications with dependent variables the I/B/E/S Price (P) and a single independent variable in each model, i.e., a pseudo target price produced by a specific REP ratio. More specifically, Pseudo-TP₁ is the pseudo target price derived from the REP ratio that ignores future growth opportunities and uses r_CAPM as cost of equity; Pseudo-TP₂ is the pseudo target price derived from the REP ratio that ignores future growth opportunities and uses r_tf as cost of equity; Pseudo-TP₃ is the pseudo target price derived from the growth-adjusted REP ratio that uses r_CAPM as cost of equity; Pseudo-TP₄ is the pseudo target price derived from the growth-adjusted REP ratio that uses r_tf as cost of equity; Pseudo-TP₅ is the pseudo target price from the REP ratio that ignores future growth opportunities and employs r_e= 9% as the cost of equity; and Pseudo-TP₆ is the pseudo target price from the REP ratio that assumes a constant future growth rate and uses the cost of equity r_e = 9%. Variable definitions and datatypes are provided in Table 2. ***Statistically significant values at 1%. **Statistically significant at 5%. *Statistically significant at 10%.

Table 8. The justification of financial analysts’ target prices by pseudo-target prices based on $\mathit{REP}$.

Independent variable	$\mathit{TP}\left(\mathit{M}1\right)$		$\mathrm{TP}\left(\mathit{M}2\right)$		$\mathrm{TP}\left(\mathit{M}3\right)$		$\mathit{TP}\left(\mathit{M}4\right)$		$\mathit{TP}\left(\mathit{M}5\right)$		$\mathit{TP}\left(\mathit{M}6\right)$
	coefficient	p-value	Coefficient	p-value	coefficient	p-value	coefficient	p-value	coefficient	p-value	coefficient	p-value
$\mathit{Pseudo}-\mathrm{TP}1$	1.105***	0.000
$\mathit{Pseudo}-\mathrm{TP}2$			0.957***	0.000
$\mathit{Pseudo}-\mathrm{TP}3$					0.646***	0.000
$\mathit{Pseudo}-\mathrm{TP}4$							0.567***	0.000
$\mathit{Pseudo}-\mathrm{TP}5$									1.385***	0.000
$\mathit{Pseudo}-\mathrm{TP}6$											1.001***	0.000
Intercept	12.20***	0.000	19.41***	0.000	22.07***	0.000	29.05***	0.000	9.717***	0.000	16.29***	0.000
Number of Obs.	10,947		10,947		10,379		10,216		10,947		10,379
R-squared	0.897		0.886		0.874		0.869		0.904		0.891

Note: The table reports the results of our OLS regression analysis with firm/year fixed effects that assesses the ability of the REP ratio to justify the financial analysts’ consensus target prices for our sample firms. The Table presents six model specifications with dependent variable the I/B/E/S Target Price Mean (TP) and a single independent variable in each model, i.e., a pseudo target price produced by a specific REP ratio. More specifically, Pseudo-TP₁ is the pseudo target price derived from the REP ratio that ignores future growth opportunities and uses r_CAPM as cost of equity; Pseudo-TP₂ is the pseudo target price derived from the REP ratio that ignores future growth opportunities and uses r_tf as cost of equity; Pseudo-TP₃ is the pseudo target price derived from the growth-adjusted REP ratio that uses r_CAPM as cost of equity; and Pseudo-TP₄ is the pseudo target price derived from the growth-adjusted REP ratio that uses r_tf as cost of equity; Pseudo-TP₅ is the pseudo target price from the REP ratio that ignores future growth opportunities and employs re = 9% as the cost of equity; and Pseudo-TP₆ is the pseudo target price from the REP ratio that assumes a constant future growth rate and uses the cost of equity re = 9%. Variable definitions and datatypes are provided in Table II. ***Statistically significant values at 1%. **Statistically significant at 5%. *Statistically significant at 10%.

Table 9. The prediction of 1-year forward stock returns by the $\mathit{REP}$.

Independent variable	$\mathit{Ri}$(M1)	p-value	$\mathit{Ri}$ (M2)	p-value	$\mathit{Ri}$ (M3)	p-value	$\mathit{Ri}$ (M4)	p-value	$\mathit{Ri}$ (M5)	p-value	$\mathit{Ri}$(M6)	p-value
$\mathit{dREP}\mathrm{\_}1$	−0.057***	0.000
$\mathit{dREP}\mathrm{\_}2$			−0.054***	0.003
$\mathit{dREP}\mathrm{\_}3$					−0.031**	0.035
$\mathit{dREP}\mathrm{\_}4$							−0.027*	0.069
$\mathit{dREP}\mathrm{\_}5$									−0.062***	0.001
$\mathit{dREP}\mathrm{\_}6$											−0.045***	0.003
$\mathit{SIZE}$	−0.183***	0.000	−0.184***	0.000	−0.203***	0.000	−0.201***	0.000	−0.184***	0.000	−0.203***	0.000
$\mathit{EV}/\mathit{EBITDA}$	−0.001**	0.025	−0.001**	0.024	−0.001**	0.012	−0.001**	0.018	−0.001**	0.027	−0.001**	0.0152
$\mathit{LEVERAGE}$	−0.003	0.547	−0.003	0.576	−0.001	0.833	0.000	0.940	−0.003	0.558	−0.001	−0.797
$\mathit{SALES}\mathrm{\_}\mathit{GROWTH}$	−0.055**	0.012	−0.055**	0.013	−0.053**	0.017	−0.054**	0.017	−0.055**	0.013	−0.053**	0.018
$\mathit{WC}$	0.049	0.588	0.045	0.618	0.047	0.610	0.033	0.729	0.044	0.627	0.050	0.583
$\mathit{ROA}$	−0.006***	0.000	−0.006***	0.000	−0.006***	0.000	−0.006***	0.000	−0.006***	0.000	−0.006***	0.000
Observations	7,317		7,317		7,114		6,955		7,317		7,114
R-squared	0.513		0.513		0.511		0.515		0.513		0.511

Note: The table reports the results of $\mathrm{OLS}$ regression analysis with firm/year fixed effects, that assesses the ability of the $\mathrm{REP}$to predict the one-year forward stock returns. We include the firm’s $\mathrm{SIZE}$, $\mathrm{EV}/\mathrm{EBITDA}$, LEVERAGE, $\mathrm{SALES}\mathrm{\_GROWTH}$, $\mathrm{WC},$ and $\mathrm{ROA}$ as control variables: a) $\mathrm{SIZE}$ is the natural logarithm of the firm’s market capitalization (MV); b) $\mathrm{EV}/\mathrm{EBITDA}$ is defined as the sum of the firm’s market value (MV) and net debt (WC18199), divided by the EBITDA (WC18198) at the fiscal year end date; c) $\mathrm{LEVERAGE}$ is defined as is the firm’s debt ratio, measured as equal to the total debt (WC03255) scaled by the total assets (WC02999) at the fiscal year end date; d) $\mathrm{SALES}\mathrm{\_GROWTH}$ is defined as the percentage change of total sales over the previous year (WC01001); e) $\mathrm{WC}$ is the working capital (WC03151) scaled by total assets (WC02999) at the fiscal year end date; and, f) $\mathrm{ROA}$ is defined as Net Income Before Extraordinary Items/Preferred Dividends (WC01551) scaled by Total Assets (WC02999) at the fiscal year end date. $\mathrm{dREP}\mathrm{\_}1$, $\mathrm{dREP}\mathrm{\_}2$, $\mathrm{dREP}\mathrm{\_}3$, $\mathrm{dREP}\mathrm{\_}4$, $\mathrm{dREP}\mathrm{\_}5$ and $\mathrm{dREP}\mathrm{\_}6$ are dummy variables that take the value of zero when 0<$\mathrm{REP}$<1 and the value of 1 when $\mathrm{REP}$>1.

Fama, E., & French, K. (1997). Industry costs of equity. Journal of Financial Economics, 43(2), 153–193. https://doi.org/10.1016/S0304-405X(96)00896-3

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Data availability

All data are publicly available from data sources identified in the text.