7. Conclusion
There is a vast amount of international literature that examines the relationship between stock returns and various financial statement items. While the so-called accrual anomaly of Sloan (1996) has attracted much attention, this paper studies a variation of accruals recently proposed by HHTZ (2004). Whereas accruals are simply the difference between earnings and cashflow at a single point in time, net operating assets capture the lifetime discrepancy between accounting value added and cash value added. In essence, NOA measures the extent to which past accruals have not translated into future cashflow (‘balance sheet bloat’). Prior research documents a negative relationship between US stock returns and each of accruals and NOA. This paper contributes to the literature by showing that, while accruals and NOA are closely related, they provide unique signals for future returns. That is, accruals and NOA both display a statistically and economically significantly negative relationship with future stock returns. In fact, value-weighted spread portfolios sorted by accruals and NOA generate significant abnormal returns. NOA, however, has an important moderating influence on the accrual effect. Whereas low accrual stocks are commonly believed to consistently outperform high accrual stocks, we show that this is only the case for stocks with high levels of NOA. Viewing accruals and NOA as single- and multi-period metrics respectively, the finding implies that a high level of accruals is only ‘bad’ news when a firm has a sustained track record of accruals not translating into future cashflow (i.e., high NOA). For stocks with low NOA, a one-off incidence of high accruals does not adversely impact future returns.
