Accrued Earnings and Growth: Implications for Future Profitability and Market Mispricing

Abstract

Prior research reveals that the accrual component of profitability is less persistent than the cash flow component, and that investors fail to fully appreciate their differing implications for future profitability (Sloan 1996). However, accruals are a component of growth in net operating assets as well as a component of profitability. Just as we can disaggregate profitability into accruals and cash flows from operations, we can disaggregate growth in net operating assets into accruals and growth in long-term net operating assets. We find that, after controlling for current profitability, both components of growth in net operating assets—accruals and growth in long-term net operating assets—have equivalent negative associations with one-year-ahead return on assets. This result is consistent with conservative accounting and diminishing marginal returns on investments. We also find that, after controlling for current profitability, the market appears to equivalently overvalue accruals and growth in long-term net operating assets relative to their association with one-year-ahead ROA. Our evidence suggests that the accrual anomaly documented in Sloan (1996) is a special case of what could be viewed as a more general growth anomaly.

Anomalies and Investor Sentiment: Empirical Evidences in the Brazilian Market

“…Other studies show an inverse relation between past and following returns (Daniel, Hirshleifer, & Subrahmanyam, 1998;Hong & Stein, 1999). Still, there is evidence of a negative relation between return rate and investment (Fairfield, Whisenant, & Yohn, 2003;Titman, Wei, & Xie, 2004); high accruals and following returns (Sloan, 1996), and; equity issuance and return rate (Daniel & Titman, 2006;Pontiff & Woodgate, 2008).…”

Evaluation of the Relationship between Assets Growth Rate and Financial Performance of Manufacturing Firms in Nigeria

“…Whether growth is in current or long-term net operating assets it has been found that the market"s apparent mispricing of accruals relates to investors inability to correctly assess the implications of growth in net operating assets for future profitability. Fairfield et al (2003) argue that net operating assets growth captures the effect of diminishing marginal returns from investment growth (Stigler 1963), thus negatively effecting future profitability. They show that the market fails to understand the negative implications of net operating assets growth for future profitability in a timely fashion.…”

A Comparison of Investors’ and Analysts’ Biases in Interpreting Book-Tax Difference: Evidence from Korean Stock Market

“…In addition, we control for the market anomaly variable, which can directly affect future stock returns, unexpected earnings (SUE), accruals (ACC), the growth rate of long-term operating assets (GRLTNOA), and change of sales (CHSAL) (e.g., Thomas 1989, 1990;Fairfield, Whisenant, and Yohn 2003;Xie 2001). Finally, we include year dummies and industry dummies to control the influence of year by year effect and industry specific effect.…”

“…In particular, there have been continuous discussions over the existence and causes of market anomaly where future stock returns might be predicted through variables related with finance and accounting information, such as unexpected earnings, accruals, and growth rate of long term operating assets Thomas 1989, 1990;Sloan 1996;Xie 2001;Fairfield, Whisenant, and Yohn 2003). Lev and Nissim (2004) expanded prior studies and reported that the investors failed to reflect BTD properly to predict future returns for the U.S. firms.…”