The Role of Life Cycle-Wide Earnings in Forecasting and Valuation

Abstract

In this study, we investigate the existence and informational value of life cycle-wide and firm-specific earnings, and examine the extent to which these components are reflected in stock prices. We find that life cycle-wide earnings are significantly more persistent than firm-specific earnings. Investors misprice these earnings by underreacting to the common component and overreacting to the firm-specific component. Consistent with our results reflecting mispricing, we find a predictable drift in future abnormal stock returns in the direction of life cycle earnings. We additionally find that our results are not affected by industry dynamics, which further illustrates the added value of life cycle as a fundamental driver of firm profitability. Finally, we find that analysts do recognize the importance of life cycle information, and, at least partly, incorporate such information in their earnings forecasts. Our study adds to the understanding of a firm’s earnings generating process and provides additional evidence on the relevance of life cycle information in forecasting and valuation.