AA – we don’t want to give away free plugs, but for many readers those initials will mean a breakdown rescue service; it’s the man who eventually arrives to end hours of misery spent on the hard shoulder of a God-forsaken motorway. On a more sombre note, the initials stand for another rescue service, one that tackles real misery – Alcoholics Anonymous. For investors, AA can also stand for a rescue service of sorts – the ‘accruals anomaly’. Understand what goes on behind those alliterative initials and the accruals anomaly can bring profit-making opportunities. More likely, as we explain, it is a rescue service – helping to spare an investor’s equity portfolio from losses that might have been incurred. It provides an early warning system against trouble, helping to avoid losses, and that is every bit as good as capturing profits.
The accruals anomaly is one of the mysteries of investing in company shares that allows investors to make higher returns than they should, ranking close behind the January effect, the small-cap effect and the low-beta effect. In a way, it has been known since the dawn of rigorous investment research. The great Benjamin Graham drew attention to it in Security Analysis, the ground-breaking volume he co-authored with David Dodd, which was published in 1934. Graham wrote about the steps needed to discover what he labelled a company’s ‘earnings power’. This was the underlying profit that a company seemed capable of making through good and bad and, from an investor’s perspective, was well worth estimating.