Decomposition of Profitability into Financing, Investing and Operating Leverages Components and the Overstatement of Return on Net Operating Assets

2016 ◽  
Author(s):  
Uche Agburuga ◽  
Emmanuel Ibanichuka
Keyword(s):  
Net Operating Assets

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

2003 ◽  
Vol 78 (1) ◽  
pp. 353-371 ◽  
Author(s):  
Patricia M. Fairfield ◽  
J. Scott Whisenant ◽  
Teri Lombardi Yohn
Keyword(s):  
Cash Flows ◽  
Return On Assets ◽  
Growth Anomaly ◽  
Conservative Accounting ◽  
Net Operating Assets ◽  
One Year ◽  
Marginal Returns ◽  
Accrued Earnings ◽  
Special Case

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.

Accounting Conservatism, the Quality of Earnings, and Stock Returns

2002 ◽  
Vol 77 (2) ◽  
pp. 237-264 ◽  
Author(s):  
Stephen H. Penman ◽  
Xiao-Jun Zhang
Keyword(s):  
Stock Returns ◽  
Joint Effect ◽  
Accounting Conservatism ◽  
Future Earnings ◽  
Diagnostic Measures ◽  
Conservative Accounting ◽  
Future Return ◽  
Net Operating Assets ◽  
Reported Earnings

When a firm practices conservative accounting, changes in the amount of its investments can affect the quality of its earnings. Growth in investment reduces reported earnings and creates reserves. Reducing investment releases those reserves, increasing earnings. If the change in investment is temporary, then current earnings is temporarily depressed or inflated, and thus is not a good indicator of future earnings. This study develops diagnostic measures of this joint effect of investment and conservative accounting. We find that these measures forecast differences in future return on net operating assets relative to current return on net operating assets. Moreover, these measures also forecast stock returns—indicating that investors do not appreciate how conservatism and changes in investment combine to raise questions about the quality of reported earnings.

scholarly journals Changes In Special Items And Future Firm Growth

2017 ◽  
Vol 33 (5) ◽  
pp. 853
Author(s):  
Young Zik Shin ◽  
Yong Gyu Lee
Keyword(s):  
Firm Growth ◽  
Earnings Growth ◽  
Special Items ◽  
Net Operating Assets ◽  
One Year

This study examines the effect of changes in special items on future firm growth. We find that a decrease in special items reverses almost completely through one-year-ahead earnings, whereas an increase in special items is positively associated with the next year’s earnings growth. We also find that the information embedded in changes in special items is incremental to that of fundamental signals documented in the literature, thereby identifying changes in special items as an additional fundamental signal. Furthermore, we find that both an increase and a decrease in special items lead to decreases in future sales and net operating assets, suggesting an inverse U-shaped relation between changes in special items and growth in these measures. Overall, our findings underscore the importance of considering various growth measures in understanding the implication of changes in special items for future firm growth.

The Feltham-Ohlson (1995) Model: Empirical Implications

2000 ◽  
Vol 15 (3) ◽  
pp. 321-331 ◽  
Author(s):  
Jing Liu ◽  
James A. Ohlson
Keyword(s):  
Market Value ◽  
Financial Assets ◽  
Positive Coefficient ◽  
Accounting Data ◽  
Nonnegative Coefficient ◽  
Net Operating Assets ◽  
Empirical Implications

This paper develops empirical implications of the Feltham and Ohlson (1995) model, which relates a firm's market value to accounting data and their expected realizations. The key issue concerns how one conceptualizes/measures a firm's expected growth to explain its market value when the model also includes more basic accounting measures reflecting its current performance. It is shown that market value can be expressed in terms of (1) financial assets (liabilities) with a coefficient of 1, (2) the expected change in operating earnings with a nonnegative coefficient, (3) the expected operating earnings with a positive coefficient, (4) current (net) operating assets with a nonnegative coefficient, and (5) the expected change in (net) operating assets with a positive coefficient. One identifies the measure of a firm's expected growth by normalizing the last variable with current (net) operating assets. The variable will be relevant if and only if the accounting is conservative.

Information in balance sheets for future stock returns: Evidence from net operating assets

2011 ◽  
Vol 20 (5) ◽  
pp. 269-282 ◽  
Author(s):  
Georgios Papanastasopoulos ◽  
Dimitrios Thomakos ◽  
Tao Wang
Keyword(s):  
Stock Returns ◽  
Balance Sheets ◽  
Net Operating Assets

scholarly journals An International Investigation Of Conservative Bias And Accounting Practices

2010 ◽  
Vol 9 (7) ◽  
Author(s):  
Joan Hollister ◽  
Victoria Shoaf
Keyword(s):  
Stock Prices ◽  
Earnings Persistence ◽  
Short Term ◽  
Development Costs ◽  
Net Operating Assets ◽  
Relationship Of ◽  
The Impact ◽  
The Relationship ◽  
Conservative Bias

This paper investigates the relationship between conservatism of accrual accounting and the relationship described by Ohlson (1995) and Feltham and Ohlson (1995) between future profitability and both current profitability and the growth in net operating assets.  To evaluate the conservatism of accounting practices, we construct an annual index for six countries based on the relationship of depreciation and amortization expense and research and development costs expensed to the underlying long-term operating assets.  As in Fairfield, Whisenant, and Yohn (2003, hereafter FWY), the growth in net operating assets is disaggregated into growth in long-term net operating assets and accruals.  We focus on the accrual practices used by companies listed on the primary exchanges in six countries, to assess whether there are country-specific accounting differences that affect the profitability relationship, and whether such differences are related to the negative earnings persistence of the components of growth in net operating assets documented by FWY for the US.  Following FWY, we also disaggregate growth in net operating assets into growth in net long-term operating assets and growth in net short-term operating assets to assess their relative persistence.  Our findings suggest that variation in the conservative bias in accounting practices affects the impact of the growth in short-term and long-term net operating assets differently, providing evidence that the accrual anomaly is not just another representation of the growth anomaly.  Finally, we employ the Mishkin (1983) model to extend internationally the FWY findings of market inefficiency with regards to the impounding in stock prices information conveyed by investments in short-term and long-term net operating assets.

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