Review of Accounting Studies

, Volume 18, Issue 4, pp 1021–1049 | Cite as

Returns to buying earnings and book value: accounting for growth and risk

  • Stephen Penman
  • Francesco Reggiani


Historical cost accounting deals with uncertainty by deferring the recognition of earnings until the uncertainty has largely been resolved. Such accounting affects both earnings and book value and produces expected earnings growth deemed to be at risk. This paper shows that the earnings-to-price and book-to-price ratios that are the product of this accounting forecast both earnings growth and the risk to that growth. The paper also shows that the market pricing of earnings and book values in these ratios aligns with the risk imbedded in the accounting: the returns to buying stocks on the basis of their earnings yield and book-to-price are explained as a rational pricing of the risk of expected earnings growth not being realized. Accordingly, the paper provides a rationalization of the well-documented book-to-price effect in stock returns: book-to-price indicates the risk in buying earnings growth. However, growth identified by a high book-to-price as yielding a higher return in this paper is quite different from “growth” typically attributed to a low book-to-price as yielding a lower return. Accordingly, the notion of “growth” versus “value” requires modification.


Risk Stock returns Growth Earnings-to-price Book-to-price 

JEL Classification

G12 M41 



We thank Jeff Abarbanell, Andrew Ang, Sanjeev Bhojraj, Ilia Dichev, Takashi Obinata, Keywan Rasekhschaffe, and Scott Richardson for comments. Stephen Penman thanks Bocconi University, the Swedish Institute for Financial Research, and the Guanghua School of Management at Peking University for providing facilities during a sabbatical when this paper was written. Francesco Reggiani thanks the Center for Research on Corporate Administration, Finance and Regulation at Bocconi University for research support.


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Copyright information

© Springer Science+Business Media New York 2013

Authors and Affiliations

  1. 1.Graduate School of Business, Uris 612Columbia UniversityNew YorkUSA
  2. 2.Department of AccountingBocconi UniversityMilanItaly

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