Discussion Papers on Economics,
University of Southern Denmark, Department of Economics

Abstract: Value normalizes size by book equity, which is a (relatively bad) proxy for expected cash flows. X-value normalizes size by the recursive out-of-sample expectation of each firm’s net income, based on its financials, with coefficients estimated by industry. Unlike value (but similarly constructed), the resulting X-value factor is unspanned by the Fama/French factors – market, size, value, investment, and profitability – individually or in different combinations (each factor and the market; all factors together; all except value). X-value spans the value and investment premiums with a Sharpe ratio of 0.57 (compared to 0.39 for value).

Keywords: Risk premiums; stock returns; Fama and French; cash flow forecasting; out of sample

JEL-codes: G11; G12; G14

40 pages, February 19, 2020

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