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

Author

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  • Ball, Ray
  • Gerakos, Joseph
  • Linnainmaa, Juhani T.
  • Nikolaev, Valeri

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.

Suggested Citation

  • Ball, Ray & Gerakos, Joseph & Linnainmaa, Juhani T. & Nikolaev, Valeri, 2016. "Accruals, cash flows, and operating profitability in the cross section of stock returns," Journal of Financial Economics, Elsevier, vol. 121(1), pages 28-45.
    • Handle: RePEc:eee:jfinec:v:121:y:2016:i:1:p:28-45
    DOI: 10.1016/j.jfineco.2016.03.002
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    More about this item

    Keywords

    Operating profitability; Accruals; Cash flows; Anomalies; Asset pricing;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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