The Accrual Anomaly and a Yearly Long-Short Stock Strategy

Summary

The accrual anomaly is the observed negative relationship between accounting accruals and subsequent stock returns. The proposed explanation is that investors focus on reported earnings and underweight the distinction between cash earnings and accruals. If accruals are less informative about future earnings, high-accrual firms may be overpriced while low-accrual firms may be undervalued. The document notes evidence of the effect in international markets, while also describing research that finds it weakened in some periods and later rebounded.

The outlined strategy calculates balance-sheet accruals for NYSE, AMEX, and NASDAQ stocks, ranks stocks into deciles, and holds a long position in the lowest-accrual group and a short position in the highest. It rebalances each May, after annual earnings are published. The discussion cautions that high-accrual stocks can be small and illiquid, raising transaction costs, and that the long leg’s market exposure and crisis-hedging properties are uncertain. Further research distinguishes investment-related accruals from non-investment accruals, suggesting the signal may reflect both risk and mispricing.

Key ideas

• The anomaly links higher accounting accruals with lower subsequent stock returns.
• The earnings-fixation explanation says investors may overlook the cash-flow and accrual components of reported earnings.
• The described portfolio buys low-accrual stocks and shorts high-accrual stocks, rebalancing yearly in May.
• Small size, limited liquidity, and transaction costs may hinder implementation.
• Research cited in the document suggests accrual effects can vary across periods and accrual categories.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.