Where do the Future Returns of Excellent Stocks Come from? Based on the Perspectives of Value Driving, Risk Compensation, and Mispricing

Wen Zuojun; Liu Weiqi; Zhang Xindong

doi:doi:10.16538/j.cnki.fem.20240524.201

Summary

Using the daily data of Chinese A-share stocks from 2006 to 2022 and integrating the essence of excellence, this paper constructs an indicator of Advantageous Strength Level (ASL) to depict the excellence of stocks. Meanwhile, based on the irrational factors of investors under the cumulative prospect theory, this paper adopts the methods of Fama-Macbeth regression and portfolio to explore the future performance of excellent stocks and their underlying driving logic. The results indicate that excellent stocks can effectively predict future positive returns and perform robustly under different market conditions and holding periods, with the cumulative returns increasing on a monthly basis when held for one year. It is noteworthy that excellent and low-risk stocks exhibit even more outstanding future performance. Further analysis reveals that the outstanding performance of stocks fundamentally originates from the intrinsic value of the company and mispricing, rather than risk compensation mechanisms. Additionally, the characteristics of excellent stocks are not only manifested in the significant positive predictive ability of intraday returns, but also in the strong ability to overcome overnight discount losses. This paper not only verifies the predictive ability of the indicator of ASL for future returns, but also deeply explores the fundamental sources of excellent stocks’ ability to predict future returns from three aspects: value driving, traditional financial theory, and behavioral finance theory. It interprets the underlying driving logic of this indicator, demonstrates the advantages of value investment strategies, and confirms the existence of the anomaly of ASL from multiple dimensions, providing empirical evidence for the applicability of value investment strategies in the Chinese market and asset pricing research.