Article2007

Earnings, Cash Flows, and Ex Post Intrinsic Value of Equity

129 citations0/0 files storedThe Accounting Review

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Financial Reporting and Valuation Research Financial Markets and Investment Strategies Auditing, Earnings Management, Governance

Abstract

We reexamine the relative importance of earnings and operating cash flows in equity valuation. In contrast to previous studies that use stock returns (Dechow 1994) or future operating cash flows (Barth et al. 2001), we use ex post intrinsic value of equity as the criterion for comparison. We determine ex post intrinsic value of equity by discounting future dividends over a three-year horizon and market price at the end of the horizon by industry cost of equity. The advantage of the ex post intrinsic value measure over stock returns is that it is not contaminated by the stock market's fixation on reported earnings (Sloan 1996). Also, unlike finite horizon future operating cash flows, ex post intrinsic values better reflect the magnitude, timing, and uncertainty of investors' future cash flows (SFAC No. 1, FASB 1978). Our results suggest that accrualbased earnings dominate operating cash flows as a summary indicator of ex post intrinsic value.

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References

1995Earnings, Book Values, and Dividends in Equity Valuation*1994Accounting earnings and cash flows as measures of firm performance 1995The information content of losses 1992Valuation: Measuring and managing the value of companies 2001The relevance of the value-relevance literature for financial accounting standard setting 2002Errors in Estimating Accruals: Implications for Empirical Research 1996The pricing of discretionary accruals 1998The relation between earnings and cash flows

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