Construction, Real Uncertainty, and Stock-Level Investment Anomalies

We offer evidence that the subsample of firms building additional capacity drives the anomalous but non-persistent negative relation between real investments and future stock returns. We develop a real options model to rationalize that evidence based on the premise that firms need to learn how to best operate modern capacity vintages, inducing idiosyncratic uncertainty in that capacity’s production costs over the learning period. Conversely, the uncertainty lowers the expected return of firms with newly-built capacity until it is resolved. Further evidence based on profit sensitivities to aggregate conditions; analyst forecast-error volatilities; and high-vs.-low tech industry subsamples supports our uncertainty explanation.