Measures the accrual component of earnings relative to total assets. When cash flow exceeds reported earnings, the company has high-quality earnings. Large accruals relative to assets are a red flag for potential manipulation.
Formula
Description
Measures the accrual component of earnings relative to total assets. Lower (more negative) values indicate earnings are well-supported by cash flow, which is a sign of high-quality accounting. The Sloan accrual anomaly research showed that companies with low accruals outperform those with high accruals.
Interpretation
Below -0.05 is favorable, meaning cash flow exceeds earnings. Above 0.05 suggests earnings may be inflated by accruals. Large positive values are a red flag for potential earnings manipulation. This concept underlies the Beneish M-Score.
Related Risk Indicators
Whether gross margins are improving or declining over five years. A positive trend means the company is gaining pricing power or reducing costs. Negative trends in a mature business are a warning sign.
Whether bottom-line profitability is improving or declining over five years. A positive trend indicates the business is becoming more profitable. The most durable improvement comes from expanding gross margins rather than cost-cutting.
The lowest ROIC recorded over five years. A company with a high minimum ROIC (above 10%) maintains strong returns even in bad years, indicating a genuinely strong business with a durable competitive advantage.
How many years in a row the company has grown revenue. Above 5 is strong, above 10 is exceptional. Long streaks indicate consistent demand and management execution. A break in a long streak deserves careful investigation.
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