Average Returns, B/M, and Share Issues

The book-to-market ratio (B/M) is a noisy measure of expected stock returns because it also varies with expected cashflows. Our hypothesis is that the evolution of B/M, in terms of past changes in book equity and price, contains independent information about expected cashflows that can be used to improve estimates of expected returns. The tests support this hypothesis, with results that are largely but not entirely similar for Microcap stocks (below the 20(th) NYSE market capitalization percentile) and All but Micro stocks (ABM).