Market Reactions to Tangible and Intangible Information Revisited

Daniel and Titman (2006) propose that the value premium is due to investors overreacting to intangible information. They therefore decompose five-year changes in firms’ book-to-market ratios into stock returns and a residual that is a proxy for tangible information based on accounting performance (“book returns”). Consistent with investors overreacting to intangible information, they find that only stock returns orthogonal to book returns reverse. We show that their decomposition creates a book return polluted by past book-to-market ratios, stock returns, net issuances, and dividends. Empirically, twofifths of the variation in book returns is due to these factors. In addition, the Daniel and Titman (2006) result is sensitive to methodological choices. When we use the change in the book value of equity as a proxy for tangible information, only the tangible component of stock returns reverses. Moreover, current book-to-market subsumes the intangible return’s power to predict the cross-section of average returns, which casts doubt on the argument that book-to-market forecasts returns because it is a good proxy for the intangible return.