The relationship between investment intensity and profitability measures from the perspective of foreign investors

Investment intensity, the level of investment in fixed assets relative to other resources, is crucial for long-term growth. The study focuses on the GCC region, where governments and businesses are actively diversifying economies away from oil and gas dependence. The non-financial sector in the GCC is experiencing rapid growth, contributing significantly to GDP. This study investigates the relationship between investment intensity and two non-GAAP profitability measures (EBITDA and EBIT) prevalent among investors, particularly foreign investors in the GCC. The primary research questions are: (1) Are EBITDA and/or EBIT good indicators of investment intensity in GCC economies? and (2) Do foreign investors prefer EBITDA or EBIT in determining investment intensity in GCC economies? The researchers posit that non-GAAP measures like EBITDA and EBIT provide a clearer picture of investment performance than GAAP measures, which can be influenced by accounting standards that vary across countries. The GCC context is chosen for its focus on economic diversification, the growing role of its non-financial sector, and its attractiveness to foreign investment. The existing literature on this topic offers mixed results, with studies showing both positive and negative relationships between profitability and investment intensity, primarily using GAAP measures. This study aims to fill this gap by focusing on non-GAAP measures within the context of the GCC economies.

The literature review examines various aspects of investment intensity, its measurement, and its relationship with profitability. Different proxies for measuring investment intensity are discussed, including the change in capital share, the ratio of fixed assets to total assets, and the growth of fixed assets. The review also discusses different measures of profitability, including GAAP measures like return on assets and return on equity, and non-GAAP measures like EBITDA and EBIT. The advantages and disadvantages of using non-GAAP measures are explained, highlighting the preference of investors for non-GAAP metrics due to their value relevance and ability to remove the impact of accounting policies that vary across countries. Studies showing both positive and negative associations between investment intensity and profitability using various proxies are reviewed. The absence of similar research in the GCC context regarding the use of EBITDA and EBIT in investment decision-making by foreign investors is highlighted, emphasizing the unique contribution of this study.

The study uses panel data from 205 non-financial firms listed on the stock markets of six GCC countries (KSA, Oman, Bahrain, UAE, Kuwait, and Qatar) from 2010 to 2019. The data was collected from S&P Capital IQ. Banks and financial institutions were excluded due to differing regulatory environments. The dependent variable is investment intensity (INV), measured by the change in tangible assets plus annual depreciation. Independent variables include EBITDA and EBIT. Control variables include firm size (total debt), firm age, leverage (total debt/total assets), profit growth, sales growth, and market share price growth. The study uses several econometric techniques to address potential issues inherent in panel data analysis. To handle heteroskedasticity and autocorrelation, the study employs feasible generalized least squares (FGLS) regression. The Hausman test is used to choose between fixed-effects and random-effects models. To account for unobserved heterogeneity and the dynamic nature of investment decisions, a dynamic panel data (DPD) model is used. Finally, dynamic ordinary least squares (DOLS) regression is applied to address potential endogeneity issues. Diagnostic tests (normality tests, variance inflation factor (VIF), Breusch-Pagan/Cook-Weisberg test, Durbin-Watson test) were conducted to ensure the robustness of the results. An additional GLS regression model was used to analyze the interaction effect between foreign investment, EBIT, and EBITDA on investment intensity.

Descriptive statistics show that the mean EBITDA is higher than the mean EBIT, suggesting relatively high overall financial performance in GCC firms. Investment intensity is also high, indicating substantial capital expenditure. Normality tests showed that most variables were approximately normally distributed. The VIF test confirmed that multicollinearity wasn’t a significant concern. The correlation matrix revealed positive and significant correlations between EBITDA and investment intensity, and between EBIT and investment intensity, though the correlation was stronger for EBITDA. FGLS regression confirmed the significant positive effect of EBITDA and LEV on INV and a significant negative effect of firm size and age on INV. EBIT and GRO were found to have insignificant effects on INV. In contrast to the positive correlation, GLS random effects regression showed a significant positive relationship between EBITDA and investment intensity and a significant negative relationship between EBIT and investment intensity. The DPD model supported the findings of a significant positive effect of EBITDA and a negative effect of EBIT on investment intensity. The DOLS regression confirmed that EBITDA had a positive and significant effect on INV, while EBIT's effect was insignificant. Further GLS regression analysis examining the interaction between foreign investment (FI), EBITDA, and EBIT on investment intensity revealed a positive and significant relationship between EBITDA*FI and INV, indicating a preference for EBITDA among foreign investors. Conversely, a negative and significant relationship was found between EBIT*FI and INV. These results robustly support the hypothesis that EBITDA is a preferred profitability measure for guiding investment decisions in the GCC, particularly among foreign investors.

The findings confirm the positive association between EBITDA and investment intensity in GCC countries, indicating that higher EBITDA leads to increased investment. This is consistent with the notion that EBITDA provides a more accurate reflection of a firm’s operating cash flow, particularly relevant for capital-intensive firms with significant depreciation and interest expenses. The negative relationship between EBIT and investment intensity, however, suggests that EBIT may not be a reliable predictor of investment behavior in this context due to its inclusion of depreciation and its variable nature depending on industry and country. The results reinforce the findings of prior studies regarding the use of EBITDA in capital-intensive industries. The strong preference for EBITDA among foreign investors in making investment decisions can be attributed to EBITDA's ability to represent a firm’s cash-generating ability and its ability to make fair comparisons across different industries and countries. The leverage of firms also plays a role, with the study showing a positive relationship between leverage and investment intensity, indicating a balance between risk and return.

This study provides strong evidence that EBITDA is a superior predictor of investment intensity in GCC countries compared to EBIT. Foreign investors consistently favor EBITDA as an indicator of firm performance. Policymakers and regulators should consider the importance of EBITDA in investment decision-making and encourage high-quality disclosure of both EBITDA and EBIT. Managers should prioritize providing transparent and comprehensive financial information to stakeholders. Future research could explore other non-GAAP measures or investigate the causal relationship between profitability and investment intensity.

This study relies on firm-reported financial data, potentially subject to biases. Only one measure of investment intensity (change in tangible assets) is used. The study only establishes association, not causality, between profitability and investment intensity. The findings may not be generalizable to other regions.