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

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

February 14,2017Working Paper No. 3505

Predicted stock issuers (PSIs) are firms with expected “high-investment and low-profit” (HILP) profiles that earn unusually low returns.  Over a 36-year period (1978-2013), average returns to top-decile PSIs are indistinguishable from Treasury yields.  We show these firms have lottery-like payoffs, high volatility, high Beta, and high shorting costs.  They are cash-strapped and most will need additional financing.  Top-PSIs generate future average 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 than low-PSI firms.  We conclude that top-PSIs, and HILP firms in general, earn low returns because they are more salient (i.e., sexier) to investors and thus overpriced, not because they are safer.