Mean reversion of profitability: evidence from the European-listed firms

Purpose -The purpose of this paper is to investigate the profitability of European Union (EU) firms with the aim of confirming the mean-reverting pattern documented by earlier research in the USA. In addition, the paper classifies firms by industry sectors across countries to investigate potential differences. Design/methodology/approach - The paper follows closely a model where the forecasting of profitability is done through year-by-year regressions. This approach allows the use of large samples and the year-by-year variation in the slopes. Both a linear and a nonlinear partial adjustment models are used for forecasting profitability. Findings -Findings show that the profitability does follow a mean-reverting process and that profitability forecasting can be improved substantially by exploiting the mean-reverting feature. Further analysis shows that mean reversion does not play an important role in EU countries as in the USA and there is no evidence of nonlinearity in mean reversion. It was also found that mean-reverting speed differ across industries, with utilities, financial and manufacturing among the lowest. Research limitations/implications -The sample companies are not originated from a single economy, but from 15 different countries with different macro-economic conditions that might influence their profitability. Originality/value -Studying the European market, where the institutional and financial structure of firms are different from the USA allows us to observe whether the US results are sample specific or can be generalized and applied elsewhere. The difference observed in these sample results is probably due to the fact that the US economy is more competitive than that of EU.