Measuring Operating Leverage

Posted: 1 May 2018 Last revised: 15 Feb 2020

See all articles by Huafeng (Jason) Chen

Huafeng (Jason) Chen

Fudan University - Fanhai International School of Finance (FISF)

Jason V. Chen

University of Illinois at Chicago

Feng Li

Shanghai Advanced Institute of Finance, Shanghai Jiaotong University

Pengfei Li

Tsinghua University - PBC School of Finance

Date Written: February 14, 2020

Abstract

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 and that its predictive power is stronger than previous measures of operating leverage. Operating leverage is not explained by common factors, distinct from the gross profitability effect, and is not explained by organization capital. The operating leverage factor helps explain the returns of book-to-market portfolios. 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

Suggested Citation

Chen, Huafeng (Jason) and Chen, Jason V. and Li, Feng and Li, Pengfei, Measuring Operating Leverage (February 14, 2020). Available at SSRN: https://ssrn.com/abstract=3156859 or http://dx.doi.org/10.2139/ssrn.3156859

Huafeng (Jason) Chen (Contact Author)

Fudan University - Fanhai International School of Finance (FISF) ( email )

220 Handan Road
Shanghai, 200433
China

Jason V. Chen

University of Illinois at Chicago ( email )

1200 W Harrison St
Chicago, IL 60607
United States

Feng Li

Shanghai Advanced Institute of Finance, Shanghai Jiaotong University ( email )

211 West Huaihai Road
Shanghai, Shanghai 200030
China

Pengfei Li

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengdu Road
Haidian District
Beijing 100083
China

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