Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns

47 Pages Posted: 1 Apr 2015 Last revised: 21 Sep 2015

See all articles by Ray Ball

Ray Ball

University of Chicago - Booth School of Business

Joseph J. Gerakos

Tuck School of Business at Dartmouth College; Dartmouth College - Tuck School of Business

Juhani T. Linnainmaa

USC Marshall School of Business; National Bureau of Economic Research (NBER)

Valeri V. Nikolaev

University of Chicago Booth School of Business

Date Written: September 15, 2015

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

JEL Classification: G11, G12, M41

Suggested Citation

Ball, Ray and Gerakos, Joseph J. and Linnainmaa, Juhani T. and Nikolaev, Valeri V., Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns (September 15, 2015). Journal of Financial Economics (JFE), Forthcoming; Fama-Miller Working Paper; Chicago Booth Research Paper No. 15-12. Available at SSRN: https://ssrn.com/abstract=2587199 or http://dx.doi.org/10.2139/ssrn.2587199

Ray Ball

University of Chicago - Booth School of Business ( email )

Joseph J. Gerakos

Tuck School of Business at Dartmouth College ( email )

Hanover, NH 03755
United States

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States

Juhani T. Linnainmaa (Contact Author)

USC Marshall School of Business ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Valeri V. Nikolaev

University of Chicago Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/valeri.nikolaev/index.html

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