- It corrects for the extent to which the firm is financially healthy, using Piotrowski's "financial health" indicator.
- It measures accruals in relation to earnings rather than to assets
- A hedge strategy that is long (short) firms of high (low) financial health (ignoring accruals) generates an average size-adjusted annual return of 9.36% across the entire sample.
- After excluding firms with the lowest financial health scores, a hedge strategy that is long (short) the 10% of firms with the lowest (highest) traditional accruals generates an average size-adjusted annual return of 13.64%, with 7.98% coming from the long side
- Using the total sample, a hedge strategy that is long (short) low-accrual, high financial health (high-accrual, low financial health) firms produces an average size-adjusted annual return of 22.93%, with a 14.92% from the long side. (See the first chart below.)
Read the paper here.
It looks like my students in Unknown University's Student Managed Fund will have another indicator to look at next semester.