Do Inventory Disclosures Predict Sales and Earnings?

Abstract

This study investigates what can be learned from inventory disclosures about future sales and earnings, that cannot be learned from current and past values of those same series. The findings indicate that inventory disclosures are incrementally useful in predicting sales and earnings, but that the implications of unexpected inventory vary according to the context. For manufacturers, especially those whose production is less variable relative to sales, unexpected changes in raw materials and work-in-process inventory (after controlling for current sales) are positive leading indicators of future sales, consistent with a “lead time” or “production smoothing” model of inventory. However, such changes are essentially neutral so far as earnings are concerned. In contrast, unexpected changes in manufacturers' finished goods inventory have little or no relation with future sales, and are negative leading indicators of future earnings, even after controlling for the impact of current sales on inventory levels; this is consistent with a “stockout model” of inventory. The behavior of inventory for retailers is also consistent with a stockout model. For retailers, unexpected changes in inventory are negative leading indicators of future earnings; although a positive relation with future sales exists, that effect is short-lived.

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