Conditional Versus Unconditional Persistence of RNOA Components: Implications for Valuation

Posted: 20 Dec 2009 Last revised: 11 Aug 2010

See all articles by Eli Amir

Eli Amir

Tel Aviv University

Itay Kama

University of Michigan, Stephen M. Ross School of Business

Joshua Livnat

New York University; Prudential Financial - Quantitative Management Associates

Date Written: May 15, 2010

Abstract

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, M41

Suggested Citation

Amir, Eli and Kama, Itay and Livnat, Joshua, Conditional Versus Unconditional Persistence of RNOA Components: Implications for Valuation (May 15, 2010). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1525817

Eli Amir (Contact Author)

Tel Aviv University ( email )

312 Recanati Bldg.
69978 Tel Aviv
Israel
+972 3 640-8510 (Phone)
+972 3 640-7738 (Fax)

Itay Kama

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-763-4538 (Phone)

Joshua Livnat

New York University ( email )

44 West 4th Street, Suite 10-76
Stern School of Business
New York, NY 10012-1118
United States
212-998-0022 (Phone)
212-995-4004 (Fax)

Prudential Financial - Quantitative Management Associates ( email )

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6th Fl.
Newark, NJ 07102
United States

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