Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns

Ball, Ray; Gerakos, Joseph; Linnainmaa, Juhani T.; Nikolaev, Valeri V.

doi:10.2139/ssrn.2587199

Cited by 44 publications

(112 citation statements)

References 41 publications

Supporting

Mentioning

Contrasting

Unclassified

Order By: Relevance

“…We begin our study by verifying that the three profitability anomalies exist in our sample period using both Fama–MacBeth (1973) cross‐sectional regressions and hedge portfolio analyses, thus confirming the findings of previous studies (Novy‐Marx 2013; Ball et al 2015, 2016). Next, we examine the effect of limits to arbitrage on stock return predictability based on each profitability measure (i.e., the impact of limits to arbitrage on profitability‐associated hedge portfolio returns).…”

Section: Introductionsupporting

confidence: 86%

“…As a result, to better match current expenses and revenues, they adjust gross profit by deducting SG&A expenses, define it as operating profitability, and show that it has better explanatory power in the cross‐section of stock returns than gross profitability. Furthermore, Ball et al (2016) demonstrate that an increase in operating profitability resulting from Sloan's (1996) noncash earnings component (accruals) has no relation with the cross‐section of stock returns. Thus, they exclude accruals from operating profitability and find that the resulting cash‐based operating profitability is a significant predictor of future stock performance that effectively subsumes the accrual anomaly (Dechow 1994; Sloan 1996).…”

Section: Literature Reviewmentioning

confidence: 99%

“…For the remainder of this article, we refer to SG&A expenses as net of R&D expenditure. Finally, Ball et al (2016) find that an increase in operating profitability due to Sloan's (1996) noncash earnings component (accruals) has no relation with the cross‐section of stock returns. Thus, their measure, cash‐based operating profitability, excludes accruals from operating profitability and is defined as follows:

COP / AT = \frac{Revenue false(REVT false) - COGS - SG & normalA false(XSGA - XRD false) - Accruals}{Total Assets false(AT false)},

where accruals are computed by using the balance sheet approach in accordance with Sloan (1996) as follows:

\begin{matrix} left \\ Accruals = Δ Current Assets (ACT) - Δ Cash (CH) - [Δ Current Liabilities (LCT) \\ - Δ Debt in Current Liabilities (DLC) \\ - Δ Income Taxes Payable (TXP) - Depreciation (DP)] . \end{matrix}

…”

Section: Variable Construction Sample Selection and Summary Statisticsmentioning

confidence: 99%

“…An interesting characteristic of this accounting‐based anomaly is that profitability can be defined in many ways, depending on the economic or accounting rationale. For example, Novy‐Marx (2013) formally documents the gross profitability anomaly, Ball et al (2015) demonstrate an operating profitability anomaly, and Ball et al (2016) show a cash‐based operating profitability anomaly. Given the proliferation of profitability measures in the search for improved anomalous return prediction, it is in the interest of researchers and investors alike to determine whether the anomalous returns based on various profitability measures are related to limits to arbitrage and, hence, market mispricing.…”

Section: Introductionmentioning

confidence: 99%

“…Banker et al (2019) find that SG&A expenses are mispriced and have return predictability in the cross‐section of stock returns. Furthermore, cash‐based operating profitability excludes accounting accruals from operating profit (Ball et al 2016). Studies such as Sloan (1996) show that accruals have return predictability.…”

Section: Introductionmentioning

confidence: 99%

See 4 more Smart Citations

What's in a Name? A Cautionary Tale of Profitability Anomalies and Limits to Arbitrage

DeLisle

Yüksel

Zaynutdinova

2020

J of Financial Research

View full text Add to dashboard Cite

The recent literature investigating profitability anomalies defines profitability in various ways (i.e., gross, operating, and cash based). We show that limits to arbitrage are associated with returns of gross and cash-based operating profitability anomalies, suggesting mispricing. In contrast, returns from the operating profitability strategy have no relation with barriers to arbitrage and exhibit no evidence of mispricing. Additionally, we show that the differential effects of limited arbitrage-related mispricing of gross and cash-based operating profitability anomalies are attributable to their respective correlations with selling, general, and administrative (SG&A) expense and accruals anomalies. We find that SG&A return predictability, like that of accruals, is related to limits to arbitrage. These findings suggest that investors and researchers should proceed with caution when searching for return predictability by redefining profitability measures.

show abstract

Section: Introductionsupporting

confidence: 86%

Section: Literature Reviewmentioning

confidence: 99%

COP / AT = \frac{Revenue false(REVT false) - COGS - SG & normalA false(XSGA - XRD false) - Accruals}{Total Assets false(AT false)},

where accruals are computed by using the balance sheet approach in accordance with Sloan (1996) as follows:

\begin{matrix} left \\ Accruals = Δ Current Assets (ACT) - Δ Cash (CH) - [Δ Current Liabilities (LCT) \\ - Δ Debt in Current Liabilities (DLC) \\ - Δ Income Taxes Payable (TXP) - Depreciation (DP)] . \end{matrix}

…”

Section: Variable Construction Sample Selection and Summary Statisticsmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

See 3 more Smart Citations

What's in a Name? A Cautionary Tale of Profitability Anomalies and Limits to Arbitrage

DeLisle

Yüksel

Zaynutdinova

2020

J of Financial Research

View full text Add to dashboard Cite

show abstract

Oil price risk and the cross‐section of stock returns in Turkey

Azimli

2020

Int. J Fin Econ

View full text Add to dashboard Cite

This paper tests whether the oil price risk influence the cross-section of stock returns in a net oil importing country even after controlling for standard risk factors to stock returns. The paper also tests the relative contribution of the oil price risk to the performance of factor-based asset pricing models to explain the average returns. Using firm-level data from Turkey, changes in monthly crude oil prices per barrel of oil is, respectively, added to the Capital Asset Pricing Model (CAPM), three-factor (3F) model and five-factor (5F) model and tested against the returns of portfolios constructed based on different firmspecific fundamentals. The results indicate that the oil price risk factor extracts significant coefficients in the cross-sectional regressions when conditioned against the returns even after controlling for the market and firm-specific risk factors. But, the asset pricing summary statistics used to evaluate the relative contribution of the oil price risk suggest that it cannot improve the relative performance of the base asset pricing equations to explain the average stock returns. The results reveal the effectiveness of the factor models to capture the effect of the oil price risk on average returns. The traditional 3F equation offers the highest potential among the models tested.

show abstract

The stability and downside risk to contrarian profits: Evidence from the S&P 500

Forbes¹,

Kiselev²,

Skerratt

2021

Int. J Fin Econ

View full text Add to dashboard Cite

A large literature now reports the evidence for the profitability of contrarian trading strategies. We investigate the stability of such contrarian trading strategies and their ability to generate large, potentially ruinous, losses for their users. Specifically, we ask, are the annual profits earned by contrarian strategies sufficiently stable and loss-free to keep their adherents in the game and capable of reaping returns to such long-run trading strategies? We present tests with more statistical power than hitherto, reflecting practical aspects of the operation of contrarian strategies. Specifically, the strategies are implemented only for years in which the mean return of stocks in the buy portfolio exceeds that of the sell portfolio; in addition, for each strategy, we calculate the Calmar ratio as a measure of downside risk. Using the constituents of the S&P 500 index for the years 1990-2017 inclusive, we examine a variety of simple,

show abstract

Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns

Cited by 44 publications

References 41 publications

What's in a Name? A Cautionary Tale of Profitability Anomalies and Limits to Arbitrage

What's in a Name? A Cautionary Tale of Profitability Anomalies and Limits to Arbitrage

Oil price risk and the cross‐section of stock returns in Turkey

The stability and downside risk to contrarian profits: Evidence from the S&P 500

Contact Info

Product

Resources

About