External Financing, Growth and Stock Returns

In this paper we investigate the relation of the value/growth anomaly with the anomaly on corporate financing activities. We confirm and expand earlier results that value/growth and external financing indicators are, to some degree, related predictors of stock returns in the cross section. We show that external financing indicators are incrementally informative since they pick up stock returns associated with earnings quality. Portfolios that combine information from both these indicators generate significantly higher returns than portfolios containing each individual indicator. More importantly, our analysis strongly suggests that the external financing anomaly is, to some extent, distinct from the value/growth anomaly, in that it may also reflect investors' misunderstanding of the effects of opportunistic earnings management.