Earnings-consumption Betas and Stock Valuation

This paper integrates the long-run covariance between aggregate consumption and firm earnings into the stock valuation process. After assuming that firms adjust their dividend payments toward a target dividend payout ratio, we use the intertemporal framework of the consumption capital asset pricing model (CCAPM) to explore the effect of systematic earnings risks on intrinsic stock values. Our main results show that the equilibrium price of a stock is positively related to its long-run earnings growth rate, and negatively related to its earnings-consumption beta, obtained from its long-run covariance between earnings growth and aggregate consumption growth. This suggests that long-run risk measured with earnings affects the theoretical value of a firm. Overall, our work suggests that the long-run concept of risk, using accounting earnings, represents an appropriate parameter for estimating the equity value of a firm