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We find that the negative relation between accruals and future abnormal returns documented by Sloan (1996) is due mainly to inventory changes. We propose three explanations for this result, derived from the prior literature, but find evidence inconsistent with all three explanations. To assist future investigations in formulating additional explanations, we document several empirical regularities for extreme inventory change deciles. We speculate that demand shifts explain our results, and examine the feasibility of alternative reasons for the stock market’s apparent inability to recognize the impending profitability reversals. Our evidence is consistent with earnings management masking the implications of demand shifts. Inventory changes and future returns Sloan (1996) documents a startling finding: investing long/short in firms in the bottom/top decile of accruals (scaled by average beginning and ending total assets) generates a hedge portfolio return of about 10 percent in the following year, and about 5 percent and 3 percent in the two years after that. He concludes that the stock market fails to recognize that accruals and cash flows, the two components of reported earnings, have different persistence. A