Forecasting Profitability and Earnings

Posted: 10 Mar 2000  

Eugene F. Fama

University of Chicago - Finance

Kenneth R. French

Tuck School of Business at Dartmouth; National Bureau of Economic Research (NBER)

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Abstract

There is a strong presumption in economics that, in a competitive environment, profitability is mean reverting. We provide corroborating evidence. In a simple partial adjustment model, the estimated rate of mean reversion is about 40 percent per year. But a simple partial adjustment model with a uniform rate of mean reversion misses rich non-linear patterns in the behavior of profitability. Specifically, we find that mean reversion is faster when profitability is below its mean and when it is further from its mean in either direction. We also show that the mean reversion in profitability produces predictable variation in earnings.

JEL Classification: G12

Suggested Citation

Fama, Eugene F. and French, Kenneth R., Forecasting Profitability and Earnings. Journal of Business, Vol. 73, No. 2, April 2000. Available at SSRN: https://ssrn.com/abstract=216588

Eugene F. Fama (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7282 (Phone)
773-702-9937 (Fax)

Kenneth R. French

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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