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Distinguishing between recurring and nonrecurring components of earnings using unobserved components modeling

Author

Listed:
  • Gardner, Jesse
  • Sloan, Richard G.
  • Yoon, Joon Sang

Abstract

Distinguishing between recurring and nonrecurring components of earnings is a critical task in financial analysis and valuation. Academics and quantitative investors often rely on measures of recurring and nonrecurring components derived from standardized financial databases. We use unobserved components modeling and the Kalman smoother to obtain efficient ex-post estimates of the recurring and nonrecurring components of annual earnings. We then show that popular measures are significantly misspecified and that investors appear to anticipate a significant portion of the misspecification. Finally, we identify certain misclassified items that drive misspecification and provide algorithms to improve their ex-ante classification.

Suggested Citation

  • Gardner, Jesse & Sloan, Richard G. & Yoon, Joon Sang, 2024. "Distinguishing between recurring and nonrecurring components of earnings using unobserved components modeling," Journal of Accounting and Economics, Elsevier, vol. 78(1).
    • Handle: RePEc:eee:jaecon:v:78:y:2024:i:1:s016541012400017x
    DOI: 10.1016/j.jacceco.2024.101687
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    More about this item

    Keywords

    Transitory components; Recurring earnings; Valuation; Financial analysis;
    All these keywords.

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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