Accruals anomaly

Troy Shu Accrual Presentation  

This was my final presentation on the accrual anomaly.

At the very basics, remember from accounting 101 that earnings = cash flow from operations + accruals (derived from the indirect method of calculating cash flow from ops). For example, you make a sale, which goes to revenue and earnings, the left side of the equation. For the RHS: that sale could’ve been paid in cash, in which it counts CFO; if it was made on account, it counts as an accounts receivable, an accrual. Essentially, accruals are a measure of earnings quality.

Intuitively, an investor would want to invest in a company with relatively low accruals, which means that the company generates lots of cash to pay expenses, to use to invest, etc. There are countless papers that have shown that trading a portfolio that goes long the stocks with the lowest accruals and shorts the stocks with the highest accruals is profitable, even after size and value adjusting returns. 

Rough outline of presentation:

  • What is an accrual: earnings = CFO + accrual
  • How it’s measured: usually signal = accrual/average assets
  • Three papers: trading a hedged portfolio based on accruals produces roughly 10% size and value adjusted annual returns. 
  • Improvement: percent accruals (signal=accrual/abs(earnings)) seems to be a more profitable measure of accruals
  • My replication: despite data and time constraints, ordinality of returns by deciles is still present
  • Interesting topics for future research: the death of the accrual anomaly (or what happened to performance post 2007?), scaling quarterly accruals by earnings instead of assets

Upcoming posts

Back at school. Upcoming posts: more turn of month effect, accruals, and recent performance of ETFRot. What I’ve learned: Cliff Asness of AQR, and I’m sure many others, are right, “diversification is the only free lunch in finance”. Diversification across asset classes, and across time as well? More to come…