Earnings, cash flows, and ex post intrinsic value of equity
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 accrual-based earnings dominate operating cash flows as a summary indicator of ex post intrinsic value.
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Related Subject Headings
- Accounting
- 3502 Banking, finance and investment
- 3501 Accounting, auditing and accountability
- 1501 Accounting, Auditing and Accountability
Citation
Published In
DOI
ISSN
Publication Date
Volume
Issue
Start / End Page
Related Subject Headings
- Accounting
- 3502 Banking, finance and investment
- 3501 Accounting, auditing and accountability
- 1501 Accounting, Auditing and Accountability