The Implications of Retained and Distributed Earnings for Future Profitability and Stock Returns

We examine the informational content of retained and distributed earnings for future profitability and stock returns. We find that investors act as if the components of retained earnings (current operating accruals, non current operating accruals and retained cash flows) have similar implications for future profitability, leading to an overvaluation of their differential persistence. It also appears that while they cannot distinguish between the distinct properties of distributed earnings, they correctly anticipate the persistence of net cash distributions to debt holders (net debt repayment) but underestimate the persistence of net cash distributions to equity holders (dividends minus net stock issues). Overall, our evidence suggests that the accrual anomaly documented in the accounting literature and the anomaly on net stock issues documented in the finance literature could be a subset of a larger anomaly on retained earnings