Content area
This paper uses just the items in Compustat to develop a proxy for operating leverage and studies operating leverage as a fundamental signal for predicting future earnings. The evidence indicates operating leverage is not relevant in predicting next-year EPS change but is a significant and positive predictor of long term growth in earnings, with the condition that earnings are positive in the current year and in the long-term future year. With this condition imposed, operating leverage is significant in predicting longterm growth in earnings in thirteen-of-fourteen years tested with average p-value 0.017 for the fourteen-years tested. All fourteen yearly coefficients were positive, indicating a robust, direct relationship to long-term growth. Other fundamental signals were developed and studied for free-cash flows, market share, and debt-to-assets, and evidence indicates that these three along with operating leverage significantly contribute to the explanatory/predictive power of models previously developed using the expert guidance of security analysts. In addition, evidence is consistent with the macroeconomic recessions that began during 2001 and near the end of 2007 having substantially affected the relevance of many of the studied fundamental signals during 2000 and 2006 in predicting next-year earnings changes.