Salient or safe: why do predicted stock issuers (PSIs) earn low returns?

Salient or safe: why do predicted stock issuers (PSIs) earn low returns?

By Charles M. C. Lee, Ken Li

October 20,2017Working Paper No. 3505

Accounting, Finance

Predicted stock issuers (PSIs) are firms with expected “high-investment and low-profit” (HILP) profiles that earn unusually low returns. We carefully document important features of PSI firms to provide new insights on the economic mechanism behind the HILP phenomenon. Our results show top-PSI firms are cash-strapped and dependent on external financing, and have lottery-like payoffs, high volatility, high Beta, and high shorting costs. Over the next two years, top-PSIs earn return-on-assets of -30% per year, report disappointing earnings, and experience strongly-negative analyst forecast revisions. They earn especially low returns in down markets and are nine times more likely to delist for performance reasons. We conclude that HILP firms earn low returns not because they safe, but because they are more salient to investors and are thus overpriced.