Earnings mean reversion

CFA Level II
#1

Can someone explain why mean reversion will occur slower when acruals are low and higher when accruals are high. Schweser says that this is due to inverse relationship between accruals and cash flow. I understand that point but not how that effects mean reversion

thanks

#2

accruals are low. so you are already closer to the mean.

so the reversal to the mean will be slower. When accruals are high - you are further away from the mean.

#3

if accrual are low, this means that you have high confidence in the accounting calculation of the Net income.

if you are confident with your Net Income and they are very high, they are more likely to stay high than if you have high accrual ( less confidence in you Net Income calculation ) and they are very high.

example : LIFO liquidation will give you high Net income with High accrual ( less confidence ), Since NI are anormaly high because of LIFO liquidation, they will mean revert much faster to the normal level than if those net income was very high because of new sales ( wich give you lower accruals )

#4

Thanks, so are you saying that since high accruals are low quality earnings and not sustainable then they will mean revert faster while low accuals are higher quality and are not forced to mean revert as fast?

#5

yes. at least that is my understanding.