Improving profitability forecasts with information on earnings quality

Matthias Demmer

No 2015/16, Discussion Papers from Free University Berlin, School of Business & Economics

Abstract: Prior literature documents the usefulness of the DuPont disaggregation for predicting firms future profitability, operating income, and stock market returns. In addition, research also emphasizes the importance of earnings quality information. However, there is a lack of research examining how earnings quality affects forecasts of profitability. This paper explores whether different earnings quality factors moderate the accuracy of profitability forecasts. This study contributes to the existing literature along three dimensions. First, contrary to financial statement analysis studies, I find that changes in profit margin provide incremental information for predicting changes in future return on assets. After controlling for earnings quality factors, the incremental usefulness of this accounting signal increases significantly. Second, this paper contributes to the earnings quality literature by providing an approach as how to include this information into forecasts of profitability. In doing so, I incorporate the main drivers of earnings quality (i.e. fundamental performance and the accounting system) into profitability forecasts. Last, the paper adds to the literature on how capital market participants perceive accounting information. I document that both analysts and investors appear to efficiently incorporate earnings quality information in their investment decisions.

Keywords: financial statement analysis; forecasting profitability; DuPont analysis; earnings quality; conservative accounting; persistence; growth; return on net; operating assets (search for similar items in EconPapers)
JEL-codes: M41 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-acc and nep-for
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://www.econstor.eu/bitstream/10419/110314/1/825931134.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:zbw:fubsbe:201516

Access Statistics for this paper

More papers in Discussion Papers from Free University Berlin, School of Business & Economics Contact information at EDIRC.
Bibliographic data for series maintained by ZBW - Leibniz Information Centre for Economics ().