Measuring Operating Leverage
82 Pages Posted: 1 May 2018 Last revised: 4 May 2020
Date Written: May 3, 2020
We examine a simple measure of operating leverage: the ratio of fixed costs (measured by depreciation and amortization plus selling, general, and administrative expenses) to the market (or book) value of assets. We find that this measure of operating leverage positively predicts returns. Operating leverage is not explained by common factors, distinct from the gross profitability effect, and is not explained by organization capital. Furthermore, a simple two-factor model with the operating leverage factor works at least as well as, but does not subsume, the Fama and French five-factor model.
Keywords: operating leverage, fixed costs; stock returns, factor models
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