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.
Research Article| March 01 2007
Earnings, Cash Flows, and Ex Post Intrinsic Value of Equity
The Accounting Review (2007) 82 (2): 457–481.
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K. R. Subramanyam, Mohan Venkatachalam; Earnings, Cash Flows, and Ex Post Intrinsic Value of Equity. The Accounting Review 1 March 2007; 82 (2): 457–481. doi: https://doi.org/10.2308/accr.2007.82.2.457
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