Growth Outlook and the Cross-section of Stock Returns

Do stocks with faster growth potential exhibit superior average returns? Exploiting a parameterized equity valuation model, we analytically solve for the expected rate of return. We develop theoretical restrictions under which growth outlook induces a higher expected rate of return. Empirically, we find that in certain cyclical segments of the market, stocks with higher (ex-ante) growth expectation perform better than their slower growing counterparts. Growth outlook also enhances the profitability of momentum strategies: Winners with accelerated earnings growth potential experience superior returns compared to winners with sluggish growth potential. Controlling for cross-sectional movements in earnings yield, higher growth outlook stocks tend to have more pronounced average returns. Intriguingly, small-cap stocks with low growth outlook outperform small-cap stocks with high growth outlook. Growth outlook has investment value beyond traditional strategy drivers (momentum, value and size).