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Cash Flow Duration as Overarching Stock Return Predictor

Posted in Fundamental Valuation

Does duration (relative arrival sequence) of firm cash flows explain many widely accepted equity factor returns? In their April 2019 paper entitled "Duration-Driven Returns", Niels Gormsen and Eben Lazarus investigate whether firm cash flow duration explains value, profitability, investment, low risk, idiosyncratic volatility and payout factor returns. They measure cash flow duration monthly via multiple regressions that relate analyst long-term growth estimates for each firm to its profitability, investment, low risk (market beta), idiosyncratic volatility and payout. They then each month for U.S. and global stocks separately reform four value-weighted sub-portfolios:

  1. Above-median NYSE market capitalization and top 30% of duration.
  2. Above-median NYSE market capitalization and bottom 30% of duration.
  3. Below-median NYSE market capitalization and top 30% of duration.
  4. Below-median NYSE market capitalization and bottom 30% of duration.

They specify the duration factor as return to a portfolio that is each month long (short) the two equal-weighted long-duration (short-duration) sub-portfolios. As a robustness test, they separately analyze a sample of single-stock dividend futures (dividend strips, claims to dividends to be paid out during a given calendar year), which allow varying duration characteristics while keeping maturity of cash flows fixed. Using monthly data for a broad sample of U.S. stocks starting August 1963, monthly data for global stocks starting July 1990, and annual data for 150 single-stock dividend futures with up to 5-year maturity starting January 2010, all through December 2018, they find that:

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