Changes in the Profitability-Growth Relation and the Implications for the Accrual Anomaly

Valuation research establishes growth in net operating assets (ΔNOA) as a primary predictor of future profitability. The negative relation between ΔNOA and future profitability, after controlling for current profitability, is researched extensively in the context of earnings quality, capital investment, accounting conservatism, earnings management, and the accrual anomaly. However, this study shows that while ΔNOA is negatively related to future profitability from 1967 to 1995, it is positively related to future profitability from 1996 to 2010. The negative effects of ΔNOA on future profitability (e.g., diminishing returns on investment, accruals overstatement, and excess capitalization) continue to exist, although they are now dominated by the positive implications of ΔNOA for future profitability. The positive relation between ΔNOA and future profitability grows stronger over time for reasons including increasing intangible intensity, increased volatility of economic activities, increased accounting conservatism, accounting principles shifting toward a balance sheet/fair value approach, changing characteristics of public firms, and the increasing importance of real options. The c