Current Profit Margin Research Articles

Ultra-Simple Shiller’s CAPE: How One Year’s Data Can Predict Equity Market Returns Better Than Ten

Professor Robert Shiller’s cyclically adjusted price/earnings ratio (CAPE) has proven to be a powerful descriptor, as well as a useful predictor, of long-term equity returns in the United States and many global markets. CAPE uses a 10-year average of real earnings to simultaneously filter noise in earnings and to estimate corporate profitability over a business cycle. In this article, the authors simplify the CAPE methodology by separating the filtering of noise from the detection of cyclicality in earnings. They filter noise by discarding the worst quarter’s earnings in each year, allowing them to use one year’s earnings instead of 10, and proxy temporal variation in profit margins using the sales-to-price ratio. In addition, they account for an empirical nonlinearity in the relationship between valuation ratios and equity market returns. They combine the output of two models, one based on earnings and the other on sales, to create a robust forecast of 10-year forward returns. In out-of-sample tests, their technique increases the correlation between out-of-sample-forecasts and realizations from 0.69 to 0.87, reduces the standard deviation of the forecast error for the 10-year returns of the S&amp;P 500 relative to CAPE by 40%, and linearizes the relationship between forecast and realized returns. <b>TOPICS:</b>Emerging, accounting and ratio analysis, fundamental equity analysis <b>Key Findings</b> • Campbell and Shiller’s CAPE predicts equity market returns using the average of the past 10 years’ earnings. The authors show that significantly better forecasts can be obtained using only one year’s quarterly earnings and revenues. • Noise reduction similar to that obtained using the 10-year average can be obtained by discarding the worst quarter’s earnings in each year to construct a new earnings measure based on the three best quarters’ earnings. Additionally, the sales-to-price ratio, which reflects current profit margins, usefully predicts future margins and earnings growth. • In out-of-sample tests, the new model’s predictions are statistically significant, while CAPE’s predictions are not.

DISCUSSION OF: An Empirical Investigation of the Relationship between Profitability Persistence and Firms' Choice of Business Model: Evidence from the U.S. Airline Industry

T he Collins et al. (2011) study (hereafter, CRC) examines how the competitive strategies of airlines impact the persistence of their operating earnings. The study then investigates if the persistence of earnings components, such as unit prices, costs, and productivity changes, also varies by competitive strategy. The study uses 590 observations of quarterly financial performance from 14 airline companies, over the period 1996 to 2008, to examine the impact of different competitive strategies on the persistence of profit margins and asset turnover. Two airlines’ competitive strategies are identified: network carriers and low-cost providers. The paper documents that network airlines (differentiators) have more persistent operating profit margins than low-cost carriers. Little difference is noted for total asset turnover across business models. The study also demonstrates that partitioning the change in profit margin into growth, price-recovery, and productivity components more fully explains future profit margins than current profit margin alone. The paper is a nice blend of the literatures in industrial economics and both financial and management accounting. There are two strings in the paper that are interesting to management and management accountants. One is how a firm’s competitive strategy impacts the persistence of profit margins and asset turnover ratios, which are the two key components of return on assets using the DuPont formula. The other interesting issue is the examination of how volume, price, and productivity components of profit margin changes impact earnings persistence differently across competitive strategies. As this latter part of the paper uses traditional variance analysis and productivity measures, it is particularly interesting to management accountants. Below, I discuss these two inter-related issues.

An Empirical Investigation of the Relationship between Profitability Persistence and Firms' Choice of Business Model: Evidence from the U.S. Airline Industry

ABSTRACTThis paper examines the influence of a firm's business model on the relative persistence of profitability in the U.S. airline industry. The strategic management literature describes a firm's business model as reflecting how that firm chooses to compete in the marketplace. Given this linkage between business model, competition, and the marketplace, we conjecture that the persistence of profit margin and asset turnover ratios will be influenced by firms' choices of business model. Further, we hypothesize that this choice of business model influences the relative persistence of the individual revenue and expense components of current profit margin and asset turnover ratios for future profitability ratios. We test these conjectures by (1) partitioning our sample firms according to business model (network carriers versus low-cost carriers), and (2) decomposing sample firms' profit margin and asset turnover ratios into components relating to pricing policy, input cost control, and productivity. We find that the profit margin and asset turnover ratios of network carriers tend to be more persistent than those of low-cost carriers, and that this differential persistence is reflected in the associations between current revenue and expense components, and future profit margin and asset turnover ratios.

Tracking hidden quality costs in a manufacturing company: an action research

PurposeThe purpose of this paper is to present a report on the implementation of a quality cost program in a continuous‐process manufacturing company, with particular emphasis on the unearthing of hidden quality costs, as well as gaining a closer understanding of the resistance against implementation.Design/methodology/approachUsing an action research approach, the researchers participated – directly and indirectly – in the implementation of quality costing at the case company. The research process comprises iterative cycles of gathering data through documentary reviews, observations of company operations, discussions with operatives, analyzing data, undertaking actions and evaluating results. Following Sandoval‐Chavez and Beruvides, the poor quality cost analysis includes an additional category to the conventional prevention‐appraisal‐failure model to reflect the cost of lost opportunities.FindingsThe study unearthed a significant portion of hidden quality costs which may be termed an “opportunity loss”. The findings indicate that the company's total quality costs actually far exceed its current profit margin, and that the company could improve its competitive position if it focused on the elimination of these quality costs.Research limitations/implicationsThis paper focuses on uncovering hidden quality costs. However, the measuring of quality costs only serves to identify opportunities for improvement. It is follow‐up corrective actions that will lead to organizational effectiveness. The research findings support the contention that tracking of poor quality costs is an important step in the quality management process.Originality/valueThis paper presents a proactive way of tracking hidden quality costs.

Redirecting technology to support sustainable farm management practices

Agricultural technology has increased farm production to unprecedented levels. However, return on investment is diminishing and environmental concerns conflict with current input intensive farm practices. Conventional technologies and their application such as crop breeding and management practices have focused on monocultural systems that are dependent on chemical inputs to produce optimum yields. Current profit margins are low or non-existent with these conventional non-sustainable practices and must be changed if the family farm is to survive. We propose an ecologically based approach to farm management that strives to reduce reliance on chemically intensive inputs through better use of multiple attributes inherent within agroecosystems. This approach requires a redirection in the development and application of current and emerging technologies. Examples of redirections in research and development programs for pest management practices, genetic engineering, and precision agriculture necessary to provide a more ecologically-based and sustainable farming approach are illustrated.

An Empirical Investigation of the Relationship Between Profit Margin Persistence and Firms’ Choice of Business Model: Evidence from the US Airline Industry

This paper examines the influence of a firm’s business model on the relative persistence of profit margins in the U.S. airline industry. The strategic management literature describes a firm’s business model as reflecting how that firm chooses to compete in the marketplace. Given this linkage between business model, competition and the marketplace, we conjecture that the persistence of profit margins will be influenced by firms’ choices of business model. Further, we hypothesize that this choice of business model influences the relative persistence of the individual revenue and expense components of current profit margins for future margins. We test these conjectures by (1) partitioning our sample firms according to business model (network carriers versus low-cost carriers), and (2) decomposing sample firms’ profit margins into components relating to pricing policy, input cost control, and productivity. While low-cost carriers are, on average, more profitable than their network carrier counterparts, we find that the margins of network carriers tend to be more persistent than those of low-cost carriers, and that this differential persistence is reflected in the association between current revenue and expense components and future margins.

The Determinants of Firm Profitability in Australian Manufacturing

This study provides new evidence on the determinants of the profitability of Australian manufacturing firms by analyzing a unique firm‐level data set of firm performance over the period 1984‐93. The panel nature of the data permits the estimation of dynamic profitability models over the business cycle, to test both the persistence and cyclicality of firm profitability. Econometric results suggest that lagged profitability is a significant determinant of current profit margins, and that industry concentration is positively related to firm profit margins. Also, profit margins are found to be procyciical in concentrated industries but counter‐cyclical in less concentrated industries.

Hothouse Bothers: A Case Study

This decision case concerns production and marketing problems that many ornamental growers incur. At the retail level, popular ornamental crops are often used as loss leaders to draw the public into stores to make other purchases. As a result, retail buyers are concerned not with quality but with price and volume. To meet the needs of price-conscious buyers, growers may attempt to reduce their production costs by reducing the level of production inputs, with some sacrifice in product quality. The owners of Two Sisters Greenhouses must decide whether they are going to produce lower-quality plants, change marketing strategies, or grow alternative crops to retain their current profit margins. This case study was intended for use in greenhouse management, nursery management, and floriculture courses where students assume the role of a decisionmaker in poinsettia production and marketing.

Financial evaluation of vaccination and testing alternatives for control of parvovirus-induced reproductive failure in swine

Objective To identify the preferable testing and vaccination strategy for control of porcine parvovirus (PPV) during a 6-month period. Design Decision-tree analysis and computer simulations. Sample Population Computer modeling of 300-sow farrow-to-finish herd. Procedure Serologic testing of 30 females to estimate herd PPV prevalence versus not testing any females was the initial decision alternative. On the basis of serologic test results, herds were classified into 1 of 3 PPV-risk categories: low (≥ 80% seropositive females), moderate (40 to &lt; 80% seropositive females), or high (&lt; 40% seropositive females). Vaccinating all females, only gilts, or not vaccinating was the second decision alternative. Results For initial model assumptions (test sensitivity and specificity = 0.95; test cost = $5/female; vaccination cost = $0.30/dose; vaccination efficacy = 0.95; and foregone gross margin = $10.85/pig), vaccination of all females (with or without serologic testing) was preferable, but the financially preferable option was to omit serologic testing. Most profitable vaccination option varied with foregone gross margin, vaccination cost, and efficacy. For herds in which all sows were known to be immune, vaccinating only gilts was financially preferable, and serologic testing was not warranted. Variation in expected monetary losses was less in vaccination options than with nonvaccination. Clinical Implications For most herds in the United States, serologic screening for PPV prior to selection of a vaccination program is unlikely to be cost-effective, because vaccination is inexpensive ($0.30/dose) and effective (95%). At current profit margins ($10.85/pig), vaccination of all females has the least-risk and is the preferred option.