Predicting firm profitability can be a difficult task, especially during an economic crisis. So what are the best measures to use in predicting future profitability? That’s what Gies College of Business Professor of Accountancy Theodore Sougiannis and his colleagues studied in their paper, “The Informativeness of Micro and Macro Information During Economic Crisis and Non-Crisis Periods: Evidence from Europe.”

“In crisis periods economic uncertainty increases significantly, which can affect key accounting numbers and the way they are used,” said Sougiannis, who is assistant head of the Department of Accountancy and the KPMG Distinguished Professor of Accountancy. “For example, information conveyed by micro news, such as firm accruals, could be less likely to convert into cash. This uncertainty can also affect discount rate information conveyed by macro news, such as GDP growth forecasts that are likely to be less accurate but also more needed. Thus, we cannot predict whether and how the information content of both indicators changes when the economy faces crisis conditions. We need research to find the answers.”

To find those answers, the group studied 16 European countries (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom) from 2005 to 2015. Encompassing the recent financial crisis of 2008, the researchers labeled years with positive GDP growth as non-crisis years and those with negative GDP growth as crisis years.

In analyzing the data, researchers considered two types of information content: reported profitability (a micro-level analysis of a firm’s current financial state) and macroeconomic expectations (including how the overall economic environment might affect each firm’s profitability).

The researchers found that macroeconomic expectations predicted future profitability only during non-crisis years, and that predictability was mostly limited to firms facing elastic demand (those in which consumer demand is extremely responsive to small changes in price) and firms that are not facing economic hardship. In crisis years, industries with inelastic demand – such as defense, healthcare, food, and oil and gas – are less likely to be affected by changes in the overall economic environment. For example, in an economic depression, we are more likely to eliminate our trips to the movie theater than we are to eliminate our food and gas purchases. In the European countries that were part of this study, current firm profitability was a much more accurate predictor than macroeconomic expectations in both non-crisis and crisis periods.

So what does this mean for the next economic crisis we might face? This study suggests that in trying to predict whether Apple or Microsoft will remain profitable during the next economic downturn, it’s better for investors to consider the company’s current profitability and cash flow than attempt to predict how the overall macroeconomic environment might affect those companies.

“Current profitability is a much more informative predictor than macroeconomic expectations in both non-crisis and crisis periods, which is good news for financial reporting,” Sougiannis said. “So the next time we face an economic crisis, it’s important to focus on firm-specific data and financial reports – and also understand that an economic crisis will not affect all firms equally.”

Professor Sougiannis’ paper, “The Informativeness of Micro and Macro Information During Economic Crisis and Non-Crisis Periods: Evidence from Europe,” co-authored with Leonidas Doukakis (University of Lausanne), Dimitrios Ghicas (Athens University of Economics and Business), and Georgia Siougle (Athens University of Economics and Business), has been accepted for publication in European Accounting Review.