Warranted Multiples and Future Returns

Abstract

We propose an alternative way of using accounting multiples to predict future returns. We define excess multiple as the difference between an accounting multiple and the warranted multiple based on a firm's fundamental value drivers. Firms with low excess multiples have higher one-to-three years ahead stock returns than firms that have high excess multiples. This difference in returns is economically and statistically significant and cannot be explained by Fama-French three factors or a momentum factor.