Sustainable Growth and Stock Returns

We examine relations between sustainable growth and stock returns over 1964–2007. Findings indicate that high sustainable growth firms tend to have low default risk, low book‐to‐market ratios, and low subsequent returns. Of the four sustainable growth components, we find that the net profit margin is the major determinant of subsequent returns. Results persist after controlling for asset growth and capital expenditure growth. Additional tests indicate that the sustainable growth effect is attributable to risk and not to mispricing.