The First Cut: Declining Total Assets and Positive Earnings Surprises
by John Bajkowski
Does it pay to focus on stocks with the greatest annual decline in total assets?
While it may be counter-intuitive, a recent research paper suggests that as a group, stocks with the largest increases in total assets underperform stocks with the lowest growth (or greatest decline) in total assets. This suggests that investors tend to overpay for past growth, creating mispriced stocks, while corporate managers tend to overpay to continue company growthespecially when pursuing mergers and acquisitions.
This issues First Cut is composed of domestic exchange-listed firms with the greatest single year decline in total assets. Financial stocks and utilities were excluded.
Assets can decline for a number of reasons: spin-offs, write down of assets, inventory reduction, dividend payments, etc. However, in the study, changes in non-cash operating assets (accounts receivable, inventory, and net property plant and equipment) had a very strong impact on return. Therefore, the First Cut screen also required an annual reduction in operating assets.
Earnings surprises were shown to have a strong, positive impact on stocks with low asset growth, so the First Cut looked for stocks with a positive earnings surprise (announced earnings above the consensus estimate) and at least one upward revision in expected earnings for the current fiscal year.
The inverse relationship between asset growth and subsequent stock performance was found to hold true across all sizes of companies; however, it was especially strong with smaller-cap stocks. The First Cut did not screen for company size, but the table below lists the market cap.
The 52-week price change highlights the weak stock price performance of most of these stocks. As with all contrarian strategies, one hopes that the market may have pushed down the value of these stocks below their true worth.