Abstract

Previous studies contend that an unexpected increase in inventory reflects firms' difficulty in generating sales and results in negative earnings growth and stock returns. This thesis intends to examine the persistence of the negative correlation between the unexpected increase in inventory and firms' earnings growth and to test whether and to what extent, inter-industry differences and firms' inventory holdings will affect the negative correlation. In a sample with over 85,000 observations for the period of 1950-2005, we find that the relation between inventory changes and future earnings is very sensitive to the selection of sample period. The thesis also reports empirical evidence that the negative relation between the change in inventories and firm performance could be somewhat attenuated for firms in the wholesale/ retail sector as well as for firms that normally carry low levels of inventory. In addition, we compute time-trends in inventory (scaled by sales) and its volatility for three industries, and find that both have declined since the early 1980s, and that the wholesale/retail sector's volatility of inventory (scaled by sales) is significantly lower than the other sectors over the entire sample period.