Conditional Versus Unconditional Persistence of RNOA Components: Implications for Valuation
London Business School
Tel Aviv University - Faculty of Management
New York University
May 15, 2010
Review of Accounting Studies, Forthcoming
Financial analysis often involves decomposing variables into components, emphasizing the structured hierarchy among ratios. We distinguish between unconditional persistence (a variable’s autocorrelation coefficient), and conditional persistence (the power of a variable’s persistence to explain the persistence of a variable higher in the hierarchy). We argue that a variable’s conditional persistence determines the magnitude of its market reaction, allowing us to predict the relative magnitude of the market reaction to a ratio depending on its hierarchal level in the analysis. We examine the market reaction to the DuPont ratios and find that, while the unconditional persistence of asset turnover (ATO) is larger than that of operating profit margin (OPM), the conditional persistence of OPM is larger than that of ATO. Thus, we predict and find that the market’s reaction to OPM is stronger than that to ATO. We further decompose OPM and ATO into their second-order components and show that the market reaction depends on a component’s conditional persistence.
Keywords: Persistence, DuPont Decomposition, Market Reaction, Financial Analysis, Ratios
JEL Classification: G14, M41Accepted Paper Series
Date posted: December 20, 2009 ; Last revised: August 11, 2010
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