Using Asset Turnover and Profit Margin to Forecast Changes in Profitability

Abstract

Financial statement analysis textbooks advocate disaggregating profitability into asset turnover and profit margin in performing financial analysis. In spite of the prominence of this technique, there is no evidence demonstrating its usefulness in a forecasting context. We provide evidence that disaggregating return on assets into asset turnover and profit margin does not provide incremental information for forecasting the change in return on assets one year ahead, but that disaggregating the change in return on assets into the change in asset turnover and the change in profit margin is useful in forecasting the change in return on assets one year ahead. [PUBLICATION ABSTRACT]