ABSTRACT
This paper supplements the traditional security
return model, by adding earnings yield to the risk-free rate, market risk, size,
and book-to-market equity as predictors of security returns. Earnings yield is
the ratio of net income to market price, so that it represents the segment of
market price that depends upon operating performance of the firm, rather than
market perception. This paper establishes a theoretical framework for the
earnings yield construct, describing it as a predictor of return on assets,
return on equity, economic value added, and the equity multiplier. Earnings
yield, therefore, predicts the ability to purchase productive assets, achieve a
positive return for shareholders, and increase debt capacity. Then, earnings
yield is subjected to empirical testing through a regression of its impact on
security returns, with the finding that it explained a significant amount of
the variance in security returns beyond size and book-to-market equity.