Accruals, cash flows, and operating profitability in the cross section of stock returns

Ray Ball (), Joseph Gerakos, Juhani T. Linnainmaa and Valeri Nikolaev

Journal of Financial Economics, 2016, vol. 121, issue 1, 28-45

Abstract: Accruals are the non-cash component of earnings. They represent adjustments made to cash flows to generate a profit measure largely unaffected by the timing of receipts and payments of cash. Prior research uncovers two anomalies: expected returns increase in profitability and decrease in accruals. We show that cash-based operating profitability (a measure that excludes accruals) outperforms measures of profitability that include accruals. Further, cash-based operating profitability subsumes accruals in predicting the cross section of average returns. An investor can increase a strategy’s Sharpe ratio more by adding just a cash-based operating profitability factor to the investment opportunity set than by adding both an accruals factor and a profitability factor that includes accruals.

Keywords: Operating profitability; Accruals; Cash flows; Anomalies; Asset pricing (search for similar items in EconPapers)
JEL-codes: G11 G12 M41 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (100)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:121:y:2016:i:1:p:28-45

DOI: 10.1016/j.jfineco.2016.03.002

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