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

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

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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