Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns

This study evaluates popular proxies for expected returns as predictors of accounting and stock returns. Prior research finds a tautological relation between expected returns, market-to-book, and future return on equity (ROE). Despite this, we find very few commonly-employed implied cost of equity capital (ICC) estimates are positively associated with future ROE after controlling for book-to-market. This weak association with future ROE appears to affect ICC estimates’ ability to forecast future stock returns: we find no evidence that ICC estimates contain incremental information about future stock returns beyond that contained in a linear combination of lagged ROE and book-to-market.