Earnings Relevance of Operating Leverage Proxy using Compustat Data with Models for Predicting Future Sales Including High-Low and OLS Linear Models

• In Event: Earnings & Leases

Abstract

This study uses revenue and expense items in Compustat to construct a proxy for firms’ Cost-Volume-Profit (CVP) income statements. The study then uses the CVP income statement to derive a proxy for operating leverage and uses operating leverage along with expectation models for predicting future sales, including high-low and Ordinary Least Squares (OLS) linear sales prediction models, to predict each firm’s next year, three-year, and five-year future operating income and long-term earnings growth. The study then regresses future change in operating income and long-term earnings growth on the CVP-Operating Leverage Model’s prediction of future change in operating income and long-term earnings growth. In general, the results show that the CVP-Operating Leverage Model can significantly predict future operating income and long-term earnings growth. In addition, results from hierarchical regression tests show the Model’s explanatory power for predicting future operating income and earnings growth is incremental to that of fundamental signals analyzed in prior studies.

Author

• Sherwood Lane Lambert, University of West Florida - Pensacola