New Study Identifies Stocks Likely to “Crash”

A recent article in Advisor Perspectives provides an in-depth review of a new study that examined the relationship between asset growth and stock price “crash risk.”

The study’s hypothesis was that the combined effect of asset growth from management’s attempt to “empire build”—control more resources by stockpiling projects and making investments—along with the tendency for managers to conceal bad news can lead to a stock price crash.

The study, which covered the period from 1988 through 2017, found:

  • A “significantly positive relationship between the current year’s asset growth and future years’ crash risk, with the predictive power lasting up to three years.”
  • Higher asset growth corresponds to lower future profitability.
  • The strongest predictors for future crash risk come from growth in current assets, operating liabilities and retained earnings, but other factors such as debt and stock financing also play a role.
  • Study results held during the period of the financial crisis (2008-2009).
  • Growth in retained earnings contributes to crash risk, while dividends and stock buybacks reduce it.
  • “Firms with more agency problems have incrementally higher crash risk related to asset growth, while firms with more conditionally conservative accounting practices have incrementally lower crash risk.”