Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns
47 Pages Posted: 1 Apr 2015 Last revised: 21 Sep 2015
Date Written: September 15, 2015
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: Suggested Citation