Forecasting Profitability and Earnings

Eugene F. Fama and Kenneth R. French
The Journal of Business
Vol. 73, No. 2 (April 2000), pp. 161-175
DOI: 10.1086/209638
Stable URL: http://www.jstor.org/stable/10.1086/209638
Page Count: 16
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Forecasting Profitability and Earnings
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Abstract

There is a strong presumption in economics that, in a competitive environment, profitability is mean reverting. We provide corroborating evidence. In a simple partial adjustment model, the estimated rate of mean reversion is about 38% per year. But a simple partial adjustment model with a uniform rate of mean reversion misses rich nonlinear patterns in the behavior of profitability. Specifically, we find that mean reversion is faster when profitability is below its mean and when it is further from its mean in either direction. We also show that the mean reversion in profitability produces predictable variation in earnings.