Abstract

http://ssrn.com/abstract=1126022
 
 

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The Role of Accruals in Predicting Future Cash Flows and Stock Returns


Francois Brochet


Harvard Business School

Seunghan Nam


Rensselaer Polytechnic Institute (RPI) - Accounting, Finance and Economics

Joshua Ronen


New York University (NYU) - Department of Accounting, Taxation & Business Law

2008


Abstract:     
We revisit the role of the cash and accrual components of accounting earnings in predicting future cash flows using out-of-sample predictions, firm-specific regression estimates, and different levels of aggregation of the dependent variable, with market value of equity as a proxy for all future cash flows. We find that, on average, accruals improve upon current cash flow from operations in predicting future cash flows. As accruals' contribution to the prediction of future cash flows varies significantly across firm-quarters, we proceed to investigating determinants of accruals' predictive ability for future cash flows. We find that positive accruals are more likely to improve upon current cash flow in predicting future cash flows. Accruals' contribution is also increasing in cash flow volatility and decreasing in the magnitude of discretionary accruals and of special items. Finally, portfolios formed on stock return predictions using information from current CFO and accruals yield significantly positive returns on average, as opposed to CFO alone. Hence, investors using predictions based on current accounting data to pick stocks are better off taking accruals into account. We also find that Sloan's (1996) accrual anomaly is related to our accrual contribution anomaly. Indeed, when accruals' contribution to future cash flow prediction is the highest, the accrual anomaly vanishes.

Number of Pages in PDF File: 55

Keywords: accruals, cash flows, cash flow predictions, anomalies

JEL Classification: M41, G14, M43, M44

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Date posted: April 30, 2008 ; Last revised: January 8, 2009

Suggested Citation

Brochet, Francois and Nam, Seunghan and Ronen, Joshua, The Role of Accruals in Predicting Future Cash Flows and Stock Returns (2008). Available at SSRN: http://ssrn.com/abstract=1126022 or http://dx.doi.org/10.2139/ssrn.1126022

Contact Information

Francois Brochet
Harvard Business School ( email )
Soldiers Field Road
Morgan Hall 369
Boston, MA 02163
United States
617 495 9329 (Phone)
Seunghan Nam (Contact Author)
Rensselaer Polytechnic Institute (RPI) - Accounting, Finance and Economics ( email )
United States
Joshua Ronen
New York University (NYU) - Department of Accounting, Taxation & Business Law ( email )
40 West 4th Street, Suite 400
New York, NY 10012-1118
United States
212-998-4144 (Phone)
212-995-4599 (Fax)
HOME PAGE: http://www.stern.nyu.edu/~jronen/
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