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

55 Pages Posted: 30 Apr 2008 Last revised: 8 Jan 2009

Francois Brochet

Boston University - Department of Accounting

Seunghan Nam

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

Joshua Ronen

New York University (NYU) - Department of Accounting

Date Written: 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.

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

JEL Classification: M41, G14, M43, M44

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: https://ssrn.com/abstract=1126022 or http://dx.doi.org/10.2139/ssrn.1126022

Francois Brochet

Boston University - Department of Accounting ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Seunghan Nam (Contact Author)

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

United States

Joshua Ronen

New York University (NYU) - Department of Accounting ( email )

40 West 4th Street, Suite 400
Suite 10-180
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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