Question

How conservatism score is correlated with profitability, size, market-to-book ratio, and growth rate of a company?

Answer 1

Conservatism is the tendency to escalate losses or book future losses and defer gains.

Conservatism Score can be calculated using Basu's Assymetric Timeliness Measure and by Khann and Watts Model.

Conservatism Score is correlated with Profitability, Size, Market-to-book ratio and growth rate of company in following ways:

a. Every Company is having 4 life stage ie. Introduction, growth, peak & decline phase. When the company's profitability is on rising trend, the conservatism score should be on higher side , while when the company's profitability is in decline phase, the conservatism score should be on lower side,

b. Every Company starts with lower size. Size and conservatism score has direct nextus, ie if size is small one, than the conservatism score should also low, soon the company is at bigger size, the score will also be big.

c. Conservatism Score is directly proportional to Market to Book Ratio. Higher the Conservatism Score, Higher the Market to Book Ration & lower the conservatism score, lower the Market to Book Value. Since Conservatism will lead to lesser book profits and lesser book value, the ratio tends to be on higher side as Market Value remains intact.

d. Conservatism Score has direct nexus with the growth rate of company. Higher the Growth, means higher the conservatism score, lower the growth, means lower the conservatism score.