Analysts' Reliance on Earnings and Cash Flow in Valuation

• In Event: Accounting and Forecasting

Abstract

Some academic accountants question the role of cash flow in equity valuation (e.g., Penman 2013) and, in general, academics tend to view cash flows as baseline references for earnings quality. This orientation may be inconsistent with practice, among analysts in particular, where discounted cash flow appears to dominate earnings-based valuation. We surveyed 97 financial analysts, of whom 36 were designated accountants, to obtain their views on earnings- and cash flow-based valuation models. We find that analysts rank discounted abnormal earnings models significantly lower than discounted dividend, discounted cash flow, and relative valuation (comparables) models on validity and weighting, regardless of accounting designation. Years of valuation experience did not affect these rankings either. Thus, accountants do not seem to carry a commitment or orientation towards accrual measurement into their careers as analysts, as might be expected given academics’ and standard setters’ lack of emphasis on cash flows. We discuss the relevance of these results to current financial reporting issues, including accounting for intangible assets and presentation of the statement of cash flows.

Authors

• Philip Beaulieu, University of Calgary

• George Gonzalez, Dhillon School of Business, University of Lethbridge